Debt Default Would Cripple U.S. Economy, New Analysis Warns

WASHINGTON — The U.S. economy could quickly shed a million jobs and fall into recession if lawmakers fail to raise the nation’s borrowing limit before the federal government exhausts its ability to pay its bills on time, the chief economist of Moody’s Analytics, Mark Zandi, will warn a Senate panel on Tuesday.

The damage could spiral to seven million jobs lost and a 2008-style financial crisis in the event of a prolonged breach of the debt limit, in which House Republicans refuse for months to join Democrats in voting to raise the cap, Mr. Zandi and his colleagues Cristian deRitis and Bernard Yaros wrote in an analysis prepared for the Senate Banking Committee’s Subcommittee on Economic Policy.

The warning comes at a moment of fiscal brinkmanship. House Republicans are demanding deep spending cuts from President Biden in exchange for voting to raise the debt limit, which caps how much money the government can borrow.

That debate is likely to escalate this week when Mr. Biden releases his latest budget proposal on Thursday. The president is expected to propose reducing America’s reliance on borrowed money by raising taxes on high earners and corporations. But he almost certainly will not match the level of spending cuts that will satisfy Republican demands to balance the budget in a decade.

The report also warns of stark economic damage if Mr. Biden, in an attempt to avert a default, agrees to those demands. In that scenario, the “dramatic” spending cuts that would be needed to balance the budget would push the economy into recession in 2024, cost the economy 2.6 million jobs and effectively destroy a year’s worth of economic growth over the next decade, Mr. Zandi and his colleagues wrote.

Mr. Zandi is set to testify on Tuesday before the Economic Policy Subcommittee, where Senator Elizabeth Warren, Democrat of Massachusetts, will hold a hearing on the debt limit and its economic and financial consequences.

Understand the U.S. Debt Ceiling

What is the debt ceiling? The debt ceiling, also called the debt limit, is a cap on the total amount of money that the federal government is authorized to borrow via U.S. Treasury securities, such as bills and savings bonds, to fulfill its financial obligations. Because the United States runs budget deficits, it must borrow huge sums of money to pay its bills.

The limit has been hit. What now? America hit its technical debt limit on Jan. 19. The Treasury Department will now begin using “extraordinary measures” to continue paying the government’s obligations. These measures are essentially fiscal accounting tools that curb certain government investments so that the bills continue to be paid. Those options could be exhausted by June.

What is at stake? Once the government exhausts its extraordinary measures and runs out of cash, it would be unable to issue new debt and pay its bills. The government could wind up defaulting on its debt if it is unable to make required payments to its bondholders. Such a scenario would be economically devastating and could plunge the globe into a financial crisis.

Can the government do anything to forestall disaster? There is no official playbook for what Washington can do. But options do exist. The Treasury could try to prioritize payments, such as paying bondholders first. If the United States does default on its debt, which would rattle the markets, the Federal Reserve could theoretically step in to buy some of those Treasury bonds.

Why is there a limit on U.S. borrowing? According to the Constitution, Congress must authorize borrowing. The debt limit was instituted in the early 20th century so that the Treasury would not need to ask for permission each time it had to issue debt to pay bills.

“The only real option,” Mr. Zandi said in an interview before his testimony, “is for lawmakers to come to terms and increase the debt limit in a timely way. Any other scenario results in significant economic damage.”

“The economy is very vulnerable,” he added. “Even without the debt-limit drama, the recession risks are high. It won’t take much to push us in, and this is certainly a lot more than ‘much.’”

Mr. Zandi’s analyses are frequently cited by the Biden administration in support of its economic policy proposals. In this case, Ms. Warren is using the Moody’s work to push Mr. Biden, in a letter sent to the White House this week, to resist Republican demands for spending cuts and instead continue insisting on a debt-limit increase that is not tied to any changes in fiscal policy.

“Everyone has been talking up to now about how dangerous it would be to default on the national debt, and that’s right,” Ms. Warren said in an interview. “But it would be even more dangerous to give in to the Republican cuts.”

“The president has stood strong,” she said, “and I urge him to continue to do that.”

Mr. Zandi’s projections join a growing list of warnings from forecasters on Wall Street and at Washington think tanks about the consequences of failing to increase the borrowing limit in a timely manner.

House Republicans have refused to raise the limit unless Mr. Biden agrees to deep but unspecified cuts in federal spending. They say the nation’s current levels of debt, accumulated in bipartisan fashion over two decades of the federal government spending more money than it receives in tax revenue, pose a current and future threat to economic growth.

Mr. Biden has said he welcomes a conversation about fiscal policy with Republican leaders but refuses to negotiate on the debt limit, which allows the government to borrow money to cover debts already approved by Congress.

More on the Debt Limit

The government hit its statutory $31.4 trillion debt limit in January. The Treasury Department is employing what are essentially accounting maneuvers that allow it to continue to pay all its bills on time. But those maneuvers work only for a limited time.

Independent groups like the Bipartisan Policy Center in Washington and the Congressional Budget Office have estimated that sometime this summer or early this fall, the government will no longer be able to pay everyone — including bondholders, Social Security recipients and federal employees — on time. The Moody’s team estimates that deadline, known as the X-date, will fall on Aug. 15.

The analysis considers several ways the impasse might be resolved in Washington. In one, Mr. Biden acts unilaterally to circumvent the debt limit without the help of Congress, inviting a constitutional challenge but potentially minimizing the harm to the economy. White House aides have said repeatedly that Mr. Biden will not pursue that route.

In a scenario where lawmakers’ inaction forced the Treasury Department to miss some required payments in order to make others, the analysis predicted a swift backlash from financial markets, akin to the stock plunge in 2008 when Congress at first voted down a program to shore up Wall Street banks as a global financial crisis set in. If, as in 2008, Congress reacted by quickly raising the debt limit, the lingering damage would be enough to cause a mild recession and nearly one million job losses.

If lawmakers ignored the market warnings and went months without raising the limit, the analysis concluded, “the blow to the economy would be cataclysmic.” Federal spending would plunge, a deep recession would set in and the unemployment rate would spike to more than 8 percent from 3.4 percent.

But if Mr. Biden were to accept Republicans’ budget blueprint, the analysis found, the resulting drop in federal spending on health care, education and other domestic programs would lead to a recession and widespread job loss. Low-income Americans would most likely bear a disproportionate brunt of the economic pain, it concluded.

Mr. Zandi said he favored eliminating the statutory debt limit entirely to end the threats that a potential default poses to the economy. “I just think you want to break that cycle once and for all as best you can, because it’s very counterproductive,” he said.

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