In British tabloid journalism, “reverse ferret” is what an editor yells in the newsroom to declare that the newspaper’s position on an issue has changed. A lot of American experts may be forced to go into reverse ferret mode after Oct. 17 if the U.S. busts through the debt ceiling and, contrary to warnings, nothing much happens right away.
President Obama doubled down on his debt-ceiling warning at a press conference today, saying the U.S. economy risks a “very deep recession” if Congress doesn’t raise the $16.7 trillion ceiling.
A default would without question be both harmful and stupid. But the sky would probably not fall the minute it happened. Roger Altman, chairman of New York-based investment bank Evercore Partners, told Bloomberg News’ Yalman Onaran that a default would mean “higher interest costs over some considerable period of time for the U.S. and for U.S. taxpayers.”
“If you missed an interest payment by two hours, the markets might look entirely beyond that and forgive you,” Altman added. “If you miss an interest payment by two days, four days, six days, that’s a different story. It’s very difficult to be scientific about this.”
In other words, how long it lasts is crucial. If the federal government defaults and the financial markets’ initial reaction is muted, a lot of people who made over-the-top warnings about generation-long consequences will have to change their tunes—and the public will become even more cynical. Congress will cease to take the debt ceiling seriously and it will lose its value as what House Budget Committee Chairman Paul Ryan calls a “forcing mechanism.”
This is not by any means an optimistic scenario. A soft market response may be the worst possible outcome—even worse than a swift, scary market reaction that finally galvanizes Washington into action. Here’s why: If a default doesn’t cause chaos on Day One, Congress and the White House will be tempted to prolong their game of brinkmanship into Day Two, Three, and Four, just as they have allowed the partial government shutdown to drag on for more than a week so far.
Markets and rating agencies that treat, say, an hour-long default as a forgivable glitch will lose their forgiving mood if a default drags on. Treasury debt will gradually lose its reputation as a safe harbor for investors and there could be growing dislocations in parts of finance that use Treasuries, such as repo financing and money markets. The federal government could wind up like the mythical frog that jumps to safety if put in a pot of boiling water but dies if the temperature is raised gradually.
The bond market appears to be bracing for a possible default that doesn’t last long. Evidence: Yields on one-month Treasury bills have jumped from zero in mid-September to 0.3 percent today, reflecting investors’ worries that payments on them won’t be made on time. Yields on six-month Treasury bills, which are usually higher, are now lower at 0.08 percent (although that’s double where they were yesterday).
A default remains unlikely, of course. What’s more likely is that the U.S. will reach Oct. 17 without a deal and the Treasury Department will be forced to prioritize payments on the national debt ahead of other expenses, such bills to contractors. Treasury Secretary Jacob Lew has said he can’t and won’t prioritize, but if push comes to shove he may be forced to do so. Prioritization has the same pernicious effect: By dulling the impact of the debt ceiling, it allows Washington to carry on its brinkmanship dramatics even longer, causing harm to the economy that mounts over time.
When I interviewed Julian Jessop, the London-based chief global economist of Capital Economics, he dismissed the notion that any U.S. default, however short and small, would trigger a market meltdown like the one following the 2008 bankruptcy filing of Lehman Brothers. “There are lots of important differences, both in the scale of the problem and the world’s ability to prepare for it,” Jessop said. “Lehman came out of the blue. In the case of a U.S. default, everyone’s talking about it. I would be surprised if there aren’t plans in place at the various central banks and treasuries around the world to prepare for it.” Governments will be quick to change any rules that threaten to cause a crisis by forcing holders of Treasuries to sell them en masse, Jessop said: “They’re not going to sit there and watch the system fall apart around them.”
Policymakers will do all they can to minimize the harm of a default. For example, to calm markets, the Federal Reserve might agree to accept defaulted Treasury securities as collateral for borrowing at its discount window, Goldman Sachs economists said last week.
In 2011, the last time the U.S. was seriously up against the debt ceiling, legendary investor Stanley Druckenmiller told the Wall Street Journal that a default is “not going to be catastrophic.” As Druckenmiller, a former fund manager for George Soros, said at the time: “Excuse me? Russia had a real default, and two or three years later they had all-time low interest rates.” He told the Journal he would prefer a brief default that resulted in a deal to get deficits under control over an agreement that raised the debt ceiling by papering over the deficit problem.
Unfortunately, Druckenmiller’s either-or scenario doesn’t cover all of the possibilities. Worst of all would be a default that isn’t brief and doesn’t produce a deal to get deficits under control. Then the debt ceiling becomes just another Maginot Line.
Chicken Little warnings about debt ceiling disaster make sense when default looks like a remote likelihood. They keep people from getting too close to the edge. But they become counter-productive if they don’t pan out. If you tell your daughter not to cross her eyes or they’ll get stuck that way, and then they don’t, she’ll start crossing her eyes whenever she feels like it. Washington is kind of like your cross-eyed daughter.
