Continue reading the main story
Continue reading the main story
Investors, executives and economists are preparing contingency plans as they consider the turmoil that would result from a default in the $24 trillion U.S. Treasury market.
Send any friend a story
As a subscriber, you have 10 gift articles to give each month. Anyone can read what you share.
By Joe Rennison
The U.S. debt limit has been reached and the Treasury Department is finding ways to save cash. After it runs out of maneuvers, what once seemed unfathomable could become reality: The United States defaults.
What happens next?
The far-reaching effects are hard to fully predict: from shock waves in financial markets to bankruptcies, recession and potentially irreversible damage to the nation’s long-held role at the center of the global economy.
The probability of a default remains low, at least based on opposing lawmakers’ assurances that a deal will be done to raise or suspend the debt limit and the long odds implied by trading in certain financial markets. But as the day approaches when the United States begins to run out of cash to pay its bills — which could be as soon as June 1 — investors, executives and economists around the world are gaming out what might happen immediately before, during and after, hatching contingency plans and puzzling over largely untested rules and procedures.
“We are sailing into uncharted waters,” said Andy Sparks, head of portfolio management research at MSCI, which creates indexes that track a wide range of financial assets, including in the Treasury market.
On the cusp of default, a ‘horror scenario’ comes into view.
Some corners of the financial markets have already begun to shudder, but those ripples pale in comparison to the tidal wave that builds as a default approaches. The $24 trillion U.S. Treasury market is the primary source of financing for the government as well as the largest debt market in the world.
The Treasury market is the backbone of the financial system, integral to everything from mortgage rates to the dollar, the most widely used currency in the world. At times, Treasury debt is even treated as the equivalent of cash because of the surety of the government’s creditworthiness.
Shattering confidence in such a deeply embedded market would have effects that are hard to quantify. Most agree, however, that a default would be “catastrophic,” said Calvin Norris, a portfolio manager and interest rate strategist at Aegon Asset Management. “That would be a horror scenario.”
A missed payment sets off a trading frenzy as markets begin to unravel.
The government pays its debts via banks that are members of a federal payments system called Fedwire. These payments then flow through the market’s plumbing, eventually ending up in the accounts of debt holders, including individual savers, pension funds, insurance companies and central banks.
If the Treasury Department wants to change the date it repays investors, it would need to notify Fedwire the day before a payment is due, so investors would know the government was about to default the night before it happened.
There is more than $1 trillion of Treasury debt maturing between May 31 and the end of June that could be refinanced to avoid default, according to analysts at TD Securities. There are also $13.6 billion in interest payments due, spread out over 11 dates; that means 11 different opportunities for the government to miss a payment over the course of next month.
Fedwire, the payment system, closes at 4:30 p.m. If a payment due is not made by this time, at the very latest, the markets would begin to unravel.
Stocks, corporate debt and the value of the dollar would probably plummet. Volatility could be extreme, not just in the United States but across the world. In 2011, around when lawmakers struck a last-minute deal to avoid breaching the debt limit, the S&P 500 fell 17 percent in just over two weeks. The reaction after a default could be more severe.
Perhaps counterintuitively, some Treasury bonds would be in high demand. Investors would likely dump any debt with a payment coming due soon — for example, some money market funds have already shifted their holdings away from Treasuries that mature in June — and buy other Treasury securities with payments due further in the future, still seeing them as a haven in a period of stress.
A cascade of ratings downgrades creates ‘craziness’ for bondholders.
Joydeep Mukherji, the primary credit rating analyst for the United States at S&P Global Ratings, said that a missed payment would result in the government being considered in “selective default,” by which it has chosen to renege on some payments but is expected to keep paying other debts. Fitch Ratings has also said it would slash the government’s rating in a similar way. Such ratings are usually assigned to imperiled companies and government borrowers.
Moody’s, the other major rating agency, has said that if the Treasury misses one interest payment, its credit rating would be lowered by a notch, to just below its current top rating. A second missed interest payment would result in another downgrade.
A slew of government-linked issuers would also likely suffer downgrades, Moody’s noted, from the agencies that underpin the mortgage market to hospitals, government contractors, railroads, power utilities and defense companies reliant on government funds. It would also include foreign governments with guarantees on their own debt from the United States, such as Israel.
Some fund managers are particularly sensitive to ratings downgrades, and may be forced to sell their Treasury holdings to meet rules on the minimum ratings of the debt they are allowed to hold, depressing their prices.
“I would fear, besides the first-order craziness, there’s second-order craziness too: Like, if you get two of the three of the major rating agencies downgrade something, then you have a bunch of financial institutions that can’t hold those securities,” Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said at an event in Florida on Tuesday night.
The financial system’s plumbing freezes up, making trading more costly and difficult.
Importantly, a default on one government bill, note or bond does not trigger a default across all of the government’s debt, known as “cross default,” according to the Securities Industry and Financial Markets Association, an industry group. This means that a majority of the government’s debt would remain current.
That should limit the effect on markets that rely on Treasury debt for collateral, such as trillions of dollars worth of derivatives contracts and short-term loans called repurchase agreements.
Still, any collateral affected by a default would need to be replaced. CME Group, a large derivatives clearing house, has said that while it has no plans to do so, it could prohibit short-dated Treasuries from being used as collateral, or apply discounts to the value of some assets used to secure transactions.
There is a risk that the financial system’s pipes simply freeze over, as investors rush to reposition their portfolios while big banks that facilitate trading step back from the market, making buying and selling just about any asset more difficult.
Amid this tumult in the days after a default, a few investors could be in for a major windfall. After a three-day grace period, some $12 billion of credit default swaps, a type of protection against a bond default, may be triggered. The decision on payouts is made by an industry committee that includes big banks and fund managers.
The nation’s global financial reputation is permanently diminished.
As panic subsides, confidence in the nation’s fundamental role in the global economy may be permanently altered.
Foreign investors and governments hold $7.6 trillion, or 31 percent, of all Treasury debt, making them vital to the favorable financing conditions that the U.S. government has long enjoyed.
But after a default, the perceived risk of holding Treasury debt could rise, making it more costly for the government to borrow for the foreseeable future. The dollar’s central role in world trade may also be undermined.
Higher government borrowing costs would also make it more expensive for companies to issue bonds and take out loans, as well as raise interest rates for consumers taking out mortgages or using credit cards.
Economically, according to forecasts by the White House even a brief default would result in half a million lost jobs and a somewhat shallow recession. A protracted default would push those numbers to a devastating eight million lost jobs and a severe recession, with the economy shrinking by more than 6 percent.
These potential costs — unknowable in total but widely thought to be enormous — are what many believe will motivate lawmakers to reach a deal on the debt limit. “Every leader in the room understands the consequences if we fail to pay our bills,” President Biden said in a speech on Wednesday, as negotiations between Democrats and Republicans intensified. “The nation has never defaulted on its debt, and it never will,” he added.
Joe Rennison covers financial markets and trading, a beat that ranges from chronicling the vagaries of the stock market to explaining the often-inscrutable trading decisions of Wall Street insiders. @JARennison
A version of this article appears in print on , Section
of the New York edition
with the headline:
If the U.S. Defaults, Then What?. Order Reprints | Today’s Paper | Subscribe
Continue reading the main story
What Would Happen if the U.S. Defaulted on Its Debt? ›
A default could shatter the $24 trillion market for Treasury debt, cause financial markets to freeze up and ignite an international crisis.Will the stock market crash if the US defaults on its debt? ›
The stock market will certainly take a hit if the U.S. defaults on its debt. At moments, the losses could seem significant to anyone with investments or retirement accounts. But for those with diversified portfolios who aren't nearing retirement, investment experts advise that you stay the course.Who does the US owe debt to? ›
Investors in Japan and China hold significant shares of U.S. public debt. Together, as of September 2022, they accounted for nearly $2 trillion, or about 8 percent of DHBP. While China's holdings of U.S. debt have declined over the past decade, Japan has slightly increased their purchases of U.S. Treasury securities.How do I prepare for a US debt default? ›
- Build an emergency fund. ...
- Reduce debt. ...
- Wait to buy a home. ...
- Diversify your investments but don't overdo it. ...
- Review and adjust financial plans.
That means tamping down on excess spending, making a budget, and shoring up emergency savings to cover at least three months of living expenses. Since a debt default would likely send interest rates soaring, any credit card debt you're saddled with may soon cost you more.Does China have more debt than the US? ›
The United States, holding the highest national debt globally, has a total of $31.68 trillion, representing a YoY increase of $1.3 trillion or 4.28%, reaching $30.38 trillion. Therefore, China's national debt has surged almost three times that of the United States in the past 12 months.How much does the US owe China? ›
|Rank||Country||U.S. Treasury Holdings|
|3||🇬🇧 United Kingdom||$655B|
- Sri Lanka. ...
- Portugal. Debt to GDP Ratio: 114% ...
- Cuba. Debt to GDP Ratio: 117% ...
- Bahrain. Debt to GDP Ratio: 120% ...
- Zambia. Debt to GDP Ratio: 123% ...
- Suriname. Debt to GDP Ratio: 124% ...
- Bhutan. Debt to GDP Ratio: 125% ...
- United States. Debt to GDP Ratio: 129%
There's no law saying you can't move to another country if you have debt—even if it's in collections. But if you've taken on debt in the U.S., you're contractually obligated to pay it, regardless of where you choose to live. Living abroad can make it more difficult for creditors to find you and collect on your debt.How does the US own its own debt? ›
Many people believe that much of the U.S. national debt is owed to foreign countries like China and Japan, but the truth is that most of it is owed to Social Security and pension funds right here in the U.S. This means that U.S. citizens own most of the national debt.
How long does it take to recover debt in USA? ›
The statute of limitations for collecting debt payments typically ranges from three to six years, depending on the state, but in some states it's as long as 10 years.Can debt companies take your savings? ›
If a debt collector has a court judgment, then it may be able to garnish your bank account or wages. Certain debts owed to the government may also result in garnishment, even without a judgment.Can banks remove defaults? ›
Once a default is recorded on your credit profile, you can't have it removed before the six years are up (unless it's an error). However, there are several things that can reduce its negative impact: Repayment. Try and pay off what you owe as soon as possible.What country is not in debt? ›
|Characteristic||National debt in relation to GDP|
|Hong Kong SAR||4.26%|
As of January 2023, the five countries owning the most US debt are Japan ($1.1 trillion), China ($859 billion), the United Kingdom ($668 billion), Belgium ($331 billion), and Luxembourg ($318 billion).Who does the US borrow money from? ›
The federal government borrows money from the public by issuing securities—bills, notes, and bonds—through the Treasury. Treasury securities are attractive to investors because they are: Backed by the full faith and credit of the United States government.What happens if China dumps the dollar? ›
Generally speaking, they will hold U.S. Treasury securities as a low-risk asset. The biggest effect of a broad scale dump of US Treasuries by China would be that China would actually export fewer goods to the United States. Overall, foreign countries each make up a relatively small proportion of U.S. debt-holders.Why does the US owe so much money? ›
The federal government needs to borrow money to pay its bills when its ongoing spending activities and investments cannot be funded by federal revenues alone.What causes the most debt in America? ›
Mortgage balances, the largest source of debt for most Americans, rose 5.9 percent between 2020 and 2021.What happens if a country refuses to pay its debt? ›
Today, a government that defaults may be widely excluded from further credit; some of its overseas assets may be seized; and it may face political pressure from its own domestic bondholders to pay back its debt. Therefore, governments rarely default on the entire value of their debt.
What country has more debt than the US? ›
Japan tops the ranking with central government debt of 221 percent of GDP, followed by Greece, Sudan, Eritrea, and Singapore. Not long ago, the U.S. was among the least indebted countries.Is China in a debt crisis? ›
China's debt is nearly 44% of its GDP and its local governments owe nearly $5.14 trillion. With the economic slowdown and collapse of land sales revenue, provinces and local governments in China are facing an embarrassing situation.What would happen if the stock market completely collapsed? ›
Stock market crashes wipe out equity-investment values and are most harmful to those who rely on investment returns for retirement. Although the collapse of equity prices can occur over a day or a year, crashes are often followed by a recession or depression.Does debt affect market value? ›
Debt is often cheaper than equity, and interest payments are tax-deductible. So, as the level of debt increases, returns to equity owners also increase — enhancing the company's value. If risk weren't a factor, then the more debt a business has, the greater its value would be.Who keeps the money when a stock goes down? ›
When a stock tumbles and an investor loses money, the money doesn't get redistributed to someone else. Essentially, it has disappeared into thin air, reflecting dwindling investor interest and a decline in investor perception of the stock.Should I use stocks to pay off debt? ›
Very rarely should you sell your investments to pay off debt. The one exception here is if you have high-interest debt (like an outstanding credit card balance), but even then there are alternatives to consider before using your investments as repayment.Can you lose all your money in a 401k if the market crashes? ›
Unfortunately, a stock market crash is likely to result in major declines in your 401(k) account balance, at least short term. How can I avoid losing money from my 401(k)? The best way to avoid losing money in your 401(k) — especially during a recession — is to avoid selling off all your investments.Could the entire stock market go to zero? ›
And while theoretically possible, the entire US stock market going to zero would be incredibly unlikely. It would, in fact, take a catastrophic event involving the total dissolution of the US government and economic system for this to occur.Can stock market go to zero? ›
The bottom line. The price of any stock can fall rapidly and even plummet to zero, usually when a company goes bankrupt. Whether this proves positive or negative depends on the position an investor holds. An investor in a long position can lose everything, while someone holding a short position can benefit greatly.How much debt is too much? ›
One guideline to determine whether you have too much debt is the 28/36 rule. The 28/36 rule states that no more than 28% of a household's gross income should be spent on housing and no more than 36% on housing plus debt service, such as credit card payments.
What company has the most debt? ›
- Toyota Motor Corporation. It takes money to make money. ...
- Evergrande Group. ...
- Volkswagen AG. ...
- Verizon Communications. ...
- Deutsche Bank. ...
- Ford Motor Company. ...
- Softbank. ...
Debt-to-income ratio targets
Generally speaking, a good debt-to-income ratio is anything less than or equal to 36%. Meanwhile, any ratio above 43% is considered too high.
"In the first half of 2023, the S&P 500 is expected to re-test the lows of 2022, but a pivot from the Federal Reserve could drive an asset recovery later in the year, pushing the S&P 500 to 4,200 by year-end," the investment bank said in a research note.Where do you put your money before a stock market crash? ›
- Treasury Bonds. ...
- Corporate Bond Funds. ...
- Money Market Mutual Funds. ...
- Gold Bullion. ...
- Precious Metal Funds. ...
- Real Estate Investment Trusts (REITs) ...
- Dividend Stocks. ...
- Essential Sector Stocks and Funds.
Why the stock market can be safer. Although the stock market produces volatile returns, it has a long history of outpacing inflation in the long run. So, if the money you have invested in the stock market isn't going to be used in the next few years, it's likely safer to keep your money invested than to take it out.Should I pay down debt during inflation? ›
Prioritize paying down high-interest debt
As inflation rises, central banks have been raising interest rates to make consumers spend less. These increased rates make it more expensive to borrow money, and make existing debt even more costly. For most consumers, the biggest impact of these rate hikes is on credit cards.
Our recommendation is to prioritize paying down significant debt while making small contributions to your savings. Once you've paid off your debt, you can then more aggressively build your savings by contributing the full amount you were previously paying each month toward debt.Is it smarter to invest or pay off debt? ›
Investing and paying down debt are both good uses for any spare cash you might have. Investing makes sense if you can earn more on your investments than your debts are costing you in terms of interest. Paying off high-interest debt is likely to provide a better return on your money than almost any investment.