Obama administration officials have been privately exploring with major banks and foreign investors whether the government could devise a way to avoid a severe disruption in financial markets if the federal debt ceiling is not raised, according to several people familiar with the matter.
Officials have discussed suspending some domestic spending in order to make payments to investors in U.S. bonds — which include domestic pension funds and the Chinese government — and possibly selling assets such as gold.
But the message back from the market has been discouraging: The failure to pay any significant obligations would scare away investors and undermine the financial system.
The market concerns were underscored late Thursday when the credit-rating agency Standard & Poor’s announced there was a 50 percent chance it would downgrade the United States in the next three months — and perhaps as soon as the end of this month.
S&P said it was losing confidence that U.S. officials would raise the debt ceiling and also produce a plan to rein in the federal debt over the coming years. The agency said a failure to raise the debt ceiling would force the government to withhold payments to bond investors or sharply cut government spending, which could cripple the economy.
“The positions of the administration and the Republican leadership are still very far apart,” said John Chambers, S&P managing director. “The tone of the debate has made us wonder whether a compromise can be achieved.”
The Treasury discussions are part of emergency planning to deal with the fallout from a U.S. default that could occur Aug. 3 if President Obama and Congress do not strike an agreement to raise the federal limit on borrowing.
For the first time, the White House acknowledged Thursday that it had begun these preparations. Press secretary Jay Carney said that “it would be irresponsible not to” have a plan, without discussing specifics. But he said he remained confident that lawmakers would raise the limit.
The administration’s planning, described as preliminary, is picking up as markets begin to show signs of concern.
The statement by S&P followed a warning Wednesday from Moody’s Investor Services that the United States could face a downgrade if it does not raise the debt ceiling.
Also Thursday, the Chinese government, the largest investor in Treasury bonds, with more than $1 trillion in holdings, urged the United States to pay off its debts.
“We hope that the U.S. government adopts responsible policies and measures to guarantee the interests of investors,” Foreign Ministry spokesman Hong Lei said at a briefing in Beijing.
One widely tracked financial indicator suggested growing concern among investors about a potential default. A type of financial insurance that investors buy to protect against default jumped 7 percent, reaching its highest point since early 2010, when the government was still shaking off the effects of the financial crisis.
Still, the expectations of a default in the next year, as measured by “credit default swaps,” remained low, at a 1-in-2,000 chance, according to Dow Jones Newswires. That compares with 1-in-5 odds that Greece, already in the throes of a massive debt crisis, will default.
The debt ceiling stands at $14.3 trillion, and the Treasury Department says it will run out of money on Aug. 2.
The department is projected to face a $20 billion shortfall on Aug. 3 and must pay back $87 billion in debt on Aug. 4. And Aug. 15, Treasury must pay $29 billion interest to bond investors.
But Treasury officials are deeply concerned they will not be able to make any of these payments if the debt ceiling is not raised.
For weeks, officials have been holding talks with the largest U.S. banks and investment firms, major U.S. asset managers, and major investors in Asia, the Middle East and Europe. Officials have been raising possible ways of preserving the United States’ pristine credit rating if the debt ceiling is not raised.
These solutions, which were first aired on Capitol Hill by Republicans skeptical of the debt limit, include making interest payments on the debt while dramatically cutting domestic spending. Another idea Treasury officials have discussed is selling U.S. assets such as gold, mortgages or student loans. Investors were all deeply skeptical of the proposed responses, people familiar with the discussions said.
Administration officials were told that a default and downgrade would scare away investors, such as pension funds and money-market funds, that can invest in only the highest-quality bonds, the people said.
And asset sales could cause chaos in the markets for those assets; speculators might bid extremely low prices to buy the assets, knowing the country desperately needs the money.
Beyond the hazard posed by leaving the debt ceiling unchanged, S&P also said a failure by the White House and Congress to come up with a compromise that trims $4 trillion from the deficit could lead to a downgrade of the credit rating. Negotiations between the White House and Congress have focused on reductions of half that size.