Debt Ceiling 2023: Could the Treasury Default?

A Treasury default is unprecedented in the nation’s history.

An ongoing standoff between Democratic President Joe Biden and Republican House Speaker Kevin McCarthy (R-CA) could have lasting implications for the Treasury's ability to pay our nation's financial obligations. The clock is ticking as party leaders seek to strike a deal allowing the Treasury to continue borrowing.

What's going on in Washington?

The ability of the Treasury to borrow has been an issue of growing importance over the past two decades. Issuing debt to investors is just one of the ways the Treasury supplements inflows from other sources, such as income taxes, and is closely tied to the ability of the Treasury to make all of its payments.

The Treasury is tasked with paying the government's bills, including the ongoing cost of previously enacted legislation and of repaying borrowed money. Some of the biggest responsibilities of the Treasury include paying out benefits to so-called entitlement programs, including Medicare and Social Security. The Treasury is likewise responsible for paying principal and interest payments on debt borrowed in previous years.

The Constitution grants Congress the sole authority to borrow money on behalf of the federal government, meaning that any raises to the debt ceiling must be approved by both the Senate and the House. The majority-Democrat Senate is expected to vote to increase the ceiling, but the Republican majority in the House is expected to attempt to broker a deal in exchange for their approval. The exact points up for negotiation are not yet clear, but the Republican platform has largely demanded fiscal responsibility and a reduction in government spending.

The Treasury's options

While the prospect of the Treasury running dry can be a frightening one, debt ceiling crises are not unprecedented. This year's crisis is the third one in the past 12 years. And the U.S. Treasury has a few tricks up its sleeve when it comes to honoring obligations without additional borrowing.

Although the Treasury reached the debt ceiling on Jan. 19, it did not automatically default on its obligations. Through the use of "extraordinary measures," the Treasury is able to satisfy payments as they become due in a variety of ways. Most commonly, those ways include dipping into certain investment funds held by the Treasury. Currently the Treasury anticipates being able to satisfy its obligations through June before those extraordinary measures are exhausted.

There is also a question about what the Treasury's options are should the debt ceiling not be raised by June. While some House Republicans have begun drafting a proposal directing the Treasury to prioritize certain payments, such as those made on the nation's debt, Treasury officials and economists have claimed such contingencies to be unrealistic. The Treasury may also refer back to a plan created during the 2011 debt ceiling crisis, which would call for a delay in payments.

Market effects of a default

Two ways to quantify the effect of a Treasury default are to consider 1. the cost to the United States government, and 2. the cost to American citizens. The cost to the United States government might be most notable in the cost of future borrowing. Current estimates project that Treasury debt, by virtue of being backed by the United States, can competitively offer rates 25 basis points lower than other sovereign debt.

This credibility in the market, which equates to about $60 billion of savings on interest payments annually, could be jeopardized by a Treasury default. Even the hint of a default could spook investors, as in 2011 when a drawn-out debt-ceiling fight led to the first ever downgrade of the nation's credit rating.

A much wider-reaching and harder to estimate loss in the case of default might come about through market turmoil. A 2013 report by the Federal Reserve simulated the effects of a one-month partial default by the Treasury. The simulation predicted a 30% drop in the stock market accompanied by a 10% drop in the value of the dollar, among reduced consumer confidence. The effect this could have on the personal finances of millions of Americans is hard to quantify.

Although the Treasury is not authorized for additional borrowing, it expects to be able to fulfill its obligations until June of this year. Should the debt ceiling not be raised, the effects could be catastrophic in terms of a heightened cost of borrowing and in market shockwaves. Americans will likely learn more on Wednesday, when House Speaker Kevin McCarthy is expected to meet with President Joe Biden.