Some Experts Are Bracing for a Default on U.S. Debt
Policy + Politics

Some Experts Are Bracing for a Default on U.S. Debt

If Tea Party-powered Republicans take control of the House, would the United States government be at greater risk of defaulting on its debt? Some analysts are starting to think so. The concerns don’t center on any kind of cash crunch. Global appetite for U.S. Treasury bonds is still so strong that the government can refinance and borrow more at spectacular low interest rates. Indeed, rates on 10-year Treasury bonds are just 2.4 percent.

The worry is political: that populist rage over federal spending and debt will push Republicans closer than ever before to blocking an increase in the Federal debt ceiling. If that were to actually happen, the government would be out of money by next summer and unable to make interest payments on its debt. Because a default would unleash panic in global financial markets and put the domestic economy into cardiac arrest, the chances of default are still very low. But even a brief scare of default could send shockwaves through the economy, and the brinksmanship between Republicans and Democrats is already intense.

"Ultimately, the debt ceiling is the center of the fiscal battlefield,’’ said Rob Dugger, managing director of Hanover Investment Group, a consulting firm in Alexandria, Va. That monitors fiscal conditions worldwide. "As investors look at what’s coming out from Congress and from the Obama administration’s budget in terms of spending and debt, the scale of the difference in view will become apparent to investors."

Dugger said he doesn’t expect Congress to actually push the government into default. But he said a protracted impasse over the debt ceiling will persuade investors to bet on a fiscal crisis, followed by a mix of forced spending cuts and tax increases. As a result, he predicted, investors will start marking down the value of American companies by a "fiscal adjustment cost" that reflects the likelihood of slower growth and lower profits for years to come.

House and Senate Republicans unanimously voted against the last increase in the gross federal debt ceiling in February, which raised the government’s legal borrowing limit by $1.9 trillion to $14.3 trillion.

That opposition was mostly grandstanding, because Republicans knew they didn’t have enough votes to actually risk a default. But Republicans may well win a majority of seats in the House, and possibly also the Senate, in the midterm elections on November 2. And with growing numbers of Republicans aligned with the Tea Party movement, the chances of gridlock with Democrats over taxes and spending will be higher than ever.

The political rumblings have begun. Republican candidates routinely attack Democratic opponents for supporting the last increase in the debt ceiling.

The Tea Party of Fort Lauderdale recently blasted Democratic incumbent Ron Klein for voting in favor of a higher debt limit, which it said "gave Congress an artificial ceiling so they could recklessly spend money."

In Utah, a conservative group attacked Republican Senator Robert Bennett, who lost the Republican primary, for having voted for repeated increases in the debt limit under President George W. Bush.

Beyond that, Republicans are on record not just for voting against a higher ceiling but vehemently denouncing it as well on the floor of the House and Senate. Backing away from those positions could prove difficult. That sets the stage for a high-stakes stand-off, in which Republicans demand drastic cuts in spending and Democrats push for higher taxes on the rich as their price for preventing a default.

  • Sal Russo, a co-founder of the Tea Party Express and a long-time Republican political strategist, said he doubted that a Tea-powered Republican majority would actually fight to the point of triggering a crisis. Republicans still have painful memories of that type of political brinkmanship by House Republicans that twice led to the temporary shutdown of most civilian government services in late 1995 and early 1996, during the Clinton administration. The move backfired badly with voters.

"You have a lot of luxury when you’re not in power,’’ Russo said, in an interview with The Fiscal Times last week. "You can do things that are symbolic, that you can’t do when you’re running the government. The reality is that politics and campaigns are all about creating contrasts. Governing should be all about finding the commonality between you and your opponent, so that things can get done."

Neither Tea Party activists nor their Republican allies in Congress are saying what they would do when it comes time to vote on another increase in the debt ceiling, which could be as early as next April. Max Pappas, vice president for public policy at the FreedomWorks Political Action Committee, a Tea Party ally, said, "We would hope that the newly-elected majority would find a way to do the spending cuts necessary so they wouldn’t have to raise the debt ceiling again."

"I think the Tea Party movement is asking for some boldness out of Washington," Pappas said in an interview with The Fiscal Times. "It’s not going to be pretty, it’s not going to be easy and it’s not going to be fun. It’s probably going to be painful. But it’s time they accepted the reality of scarce resources."

But a handful of conservatives outside of Congress have argued that a federal default might be a good thing. John Tamny, a fellow at the Cato Institute in Washington, argued that a default would force the government to slash spending and make it impossible to borrow again for years afterward.

Gary North, a conservative blogger who blends free-market ideology with Biblical commentary, described the virtues of a default in almost rapturous terms last week. "The Great Default will add to liberty, even though it sets back those who trusted politicians’ promises,’’ North wrote. "The credit rating of the United States government will be marked down from AAA to AA. It will then be marked down to A. For every notch down that it falls, the national day of deliverance draws closer."

For the moment, investors are assuming that Congress will muddle through as it always has before, and they are buying Treasury securities more eagerly than ever. Investors recognize the dangers of political paralysis, but they don’t know when it will hit them.

"It’s like a sip of arsenic,’’ Brennan said. "You know it’s going to kill you in the end, but you don’t know how many sips it will take."

Eric Pianin of The Fiscal Times contributed to this report.