Consequences Of Debt Default

Government Default: A Looming Calamity with Far-Reaching Consequences

Economists and decision-makers are raising the alarm with less than a week left until the United States runs out of money, using phrases like “cataclysmic event” and “calamity” to characterize the possible outcomes if Congress fails to increase the debt ceiling. Even if the immediate effects on the world financial system are worrying, it is crucial to realize that the effects will also affect regular people. Who would suffer the most and who would be the first to bear the burden of a failure to raise the debt limit?

The effects of a default can be compared to a sinkhole; depending on how long it lasts, it may first affect individuals closest to the epicenter before gradually engulfing a broader population and eventually destroying the whole U.S. economy. People who directly depend on government funding, such as workers of the government and those who receive direct payments from the government, such as retirees, veterans, and Americans with disabilities who depend on social security income, are the first people who are likely to be impacted. However, the effects might go even further, possibly affecting medical professionals who get paid by Medicare and Medicaid. Higher mortgage rates might also have a significant negative impact on potential homeowners, adding to the difficulties of an already difficult housing market. If these interruptions add up, the economy may slow down and, if the situation continues, the country may enter a deep recession.

The initial impact of a default scenario would fall mostly on individuals and institutions that depend on government payments. If the U.S. Treasury exceeded the debt ceiling, it would no longer be able to borrow money, not even to pay for already-approved commitments by Congress. As a result, the government would have to make challenging choices regarding how to distribute the existing funds. According to a recent Moody’s Analytics assessment, if a default happens, the government would probably prioritize monthly Treasury interest payments to protect its borrowing capacity and reduce financial market pandemonium. This emphasis, meanwhile, can come at the expense of direct payments to people and organizations who depend on government assistance. It is important to keep in mind that choosing to prioritize some payments over others may be against the law, putting the government at risk of facing several lawsuits.

A large number of people depend on regular government payments. Nearly 2 million federal employees could experience immediate income problems. This number does not include the 3.9 million additional veterans getting disability benefits or the roughly 1.3 million active-duty military troops. The government may use furloughs or layoffs to save money during a debt-ceiling crisis, which would leave many people without a reliable source of income. The Bipartisan Policy Center’s analysis indicates that these trade-offs might have an immediate effect because bills totalling $12 billion for promised veteran benefits are due on June 1 and another $5 billion in federal salaries and insurance are due on June 9.

By the end of 2022, 66 million Americans would also be receiving social security benefits, such as retirement or disability income. 7.6 million disabled workers who depend on Social Security Disability Insurance are among them. Due to asset and income requirements, current government laws already place restrictions on recipients’ capacity to save. As a result, missing even one payment might be extremely difficult. The Century Foundation’s Disability Economic Justice Team director, Kimberly Knackstedt, voiced concern about the instability and stress brought on by not knowing when vital checks, which are currently insufficient to pay housing and food costs, will arrive.

According to Moody’s Analytics economist Bernard Yaros, the almost 6 million people who get unemployment benefits are also at risk of interruption because the financing is dependent on federal assistance that is handled by the states. Multiple Social Security payments being late in June might have a negative multiplier effect on people. As Moody’s has noted, the effects reach beyond specific people and have an impact on businesses that do business with the federal government, like aerospace and defense companies. Healthcare organizations could experience serious setbacks, especially small, rural hospitals that depend significantly on Medicaid and Medicare funding. States like Virginia that have strong linkages to these sectors may see a localized economic slowdown that is more severe than the overall effect.

Aside from people and businesses, homebuyers would also encounter many difficulties. The housing market, which was already unstable due to the COVID-19 pandemic, has lately begun to stabilize. However, a default might start a slump, which would drive many prospective purchasers away because of rising interest rates. A further 2 percentage point hike in rates, according to senior economist Jeff Tucker of Zillow, would lead to a 23% drop from the anticipated summer pace. This would exacerbate the current housing affordability crisis and increase wealth inequality. A loan default crisis would make the situation worse, especially for those who aren’t wealthy, as the median age of first-time homebuyers climbs and access to affordable solutions is harder to come by.

The overall economy is also under considerable threat, though it might not materialize right away. A default would have effects outside of the financial markets. If those who depend on government assistance suddenly experience financial difficulties, the economy would be negatively impacted by their lower purchasing power. Therefore, even if the crisis is brief, economists foresee a probable recession brought on by a debt default. According to Moody’s predictions, prolonged economic volatility might have serious repercussions, such as higher interest rates and slower GDP over the following ten years.

Overall, the American government’s ability to conduct business is at risk, which might have long-term effects on the economy for regular people. A similar battle over the debt ceiling cost the taxpayers money in 2011 and resulted in S&P downgrading the United States’ credit rating. Major credit-rating company Fitch has already issued a caution. Even a temporary debt default sends a statement about the world’s confidence in the American political and financial systems. The economy is vulnerable since inflation is still high and there is a hidden threat of a recession notwithstanding the economy and consumers’ resiliency. The debt ceiling would only make these problems worse, possibly hastening or igniting a recession.

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