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Q&A: What happens if US breaks borrowing limit?

Saturday - 10/12/2013, 3:20pm  ET

CHRISTOPHER S. RUGABER
AP Economics Writer

WASHINGTON (AP) -- Negotiations in Congress to raise the nation's borrowing limit are up against a deadline of Thursday. If the limit isn't raised by then, the government will no longer have authority to borrow to pay its bills.

So what happens if Thursday comes and goes and the limit isn't raised?

The scary thing is, no one really knows. Going past the deadline would be unprecedented.

The possible consequences are complex. But none are good. The gravest threat is that the government would soon fail to make interest payments on its debt. Any missed payment would trigger a default.

Financial markets would sink. Social Security checks would be delayed. Eventually, the economy would almost surely slip into another financial crisis and recession.

Even if the government managed to make its interest payments, fears about a default could cause investors to dump Treasurys and send U.S. borrowing rates soaring.

Here are questions and answers about the government's borrowing limit:

Q. What exactly is it?

A. The borrowing limit is a cap on how much debt the government can accumulate to pay its bills. The government borrows in most years because its spending has long exceeded its revenue. The first borrowing limit was enacted in 1917. Since 1962, Congress has raised the borrowing limit 77 times. It now stands at $16.7 trillion.

Q. When will we reach the limit?

A. The national debt actually reached the limit in May. Since then, Treasury Secretary Jacob Lew has made accounting moves to continue financing the government without further borrowing. But Lew says those measures will be exhausted by Thursday. The government will then have to pay its bills from its cash on hand -- an estimated $30 billion -- and tax revenue.

Q. So what happens after Thursday?

A. The government could pay its bills for a few days. But sometime between Oct. 22 and Oct. 31, the cash on hand and tax revenue wouldn't be sufficient, according to the Congressional Budget Office. The date isn't exact because it's impossible to foresee precisely how much revenue the government will receive and when.

Q. When it runs out of cash, does the government default?

A. No, not right away. A default would occur if the government fails to make a principal or interest payment on any of its Treasurys. The first interest payment after Thursday's deadline is a $6 billion payment due Oct. 31.

Many experts think that to avoid a default, Treasury would make payments on the debt its top priority.

"We believe the government would continue to pay interest and principal on its debt even in the event that the debt limit is not raised, leaving its creditworthiness intact," says Moody's Investors Service, a credit rating agency.

But that is the subject of intense dispute in Washington. The House has approved a bill to require such "prioritization." The Senate hasn't passed it, though. And President Barack Obama has threatened to veto it.

Without an increase in the borrowing limit, the government couldn't pay other obligations on time, such as Social Security benefits, bills from government contractors and Medicare reimbursements. Those payments are also legal obligations, Lew argues, and failure to pay them would essentially be equivalent to a default.

In any case, making some payments and not others is harder than it might sound. Treasury makes roughly 100 million payments a month. Nearly all are automated. Lew says the Treasury's computer systems aren't equipped to choose some and not others among all those outgoing checks.

And without cash in reserve, any minor glitch could cause Treasury to miss a debt payment -- and default.

"Treasury would do everything in their power to not miss a debt payment," says Donald Marron, an economist at the Urban Institute and a former economic adviser to President George W. Bush. "But when you're in untested waters under a great deal of stress, bad things happen."

Q. What other problems might be raised by prioritization?

A. Consider the legal and political obstacles. The government is legally obligated to pay its contractors. If not, the contractors could sue for non-payment. And how long would members of Congress stand by as Treasury holders in China and other nations were paid interest, while payments to U.S. veterans and Social Security recipients were delayed?

Q. How would investors react if the government made its interest payments but fell behind on other obligations?

A. Badly, most economists say. If the government couldn't pay veterans' benefits, federal employee salaries or other bills, investors would almost certainly demand higher interest rates at future Treasury auctions. That would drive up the cost to taxpayers of servicing the government's debt.

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