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Treasury Says Default Impact Could Last More Than Generation

Treasury Says U.S. Default Impact May Last More Than Generation
An " Entrance Closed" sign hangs outside the Treasury's Pennsylvania Avenue entrance in Washington D.C., on Oct. 3, 2013. Photographer: Julia Schmalz/Bloomberg

A U.S. government default caused by Congress failing to raise the $16.7 trillion federal debt limit could have catastrophic consequences that might last decades, the Treasury Department said in a report today.

“Not only might the economic consequences of default be profound, those consequences, including high interest rates, reduced investment, higher debt payments, and slow economic growth, could last for more than a generation,” the Treasury said in the report.

The Obama administration is trying to step up the sense of urgency in Congress over the debt ceiling and the partial government shutdown that began Oct. 1. Treasury Secretary Jacob J. Lew is projecting that the U.S. will exhaust its “extraordinary measures” to stay under the limit no later than Oct. 17 and will then have about $30 billion in cash.

“In the event that a debt limit impasse were to lead to a default, it could have a catastrophic effect on not just financial markets but also on job creation, consumer spending and economic growth -- with many private-sector analysts believing that it would lead to events of the magnitude of late 2008 or worse, and the result then was a recession more severe than any seen since the Great Depression,” the Treasury said in the report.

Stalemate Continues

While the department was warning of the dangers of not raising the debt limit, President Barack Obama urged House Republicans to end the stalemate over the shutdown.

“Take a vote, stop this farce and end this shutdown right now,” Obama said today at a construction company in Rockville, Maryland, just outside Washington. He said there is only “one way out” of the government closing -- for House Speaker John Boehner to allow a vote on a stopgap spending bill without conditions.

So far, the financial-market response to the political gridlock has been muted. The Standard & Poor’s 500 Index was at 1,678.79 at 1:08 p.m. today compared with 1,681.55 on Sept. 30. The yield on the 10-year Treasury note has slipped 1 basis point to 2.60 percent, and the Dollar Index is down 0.5 percent.

International Monetary Fund Managing Director Christine Lagarde said today it’s “mission-critical” for the U.S. to raise the debt limit, warning policy makers that failure to do so would seriously hurt the country and the world.

‘Far Worse’

“The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse,” Lagarde said in remarks at George Washington University in Washington.

The Treasury report emphasized the importance of U.S. stability to the global economy.

“The U.S. dollar and Treasury securities are at the center of the international financial system,” the Treasury said. “A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

The Treasury said it sees indications of investor concerns. The yield on six-month Treasury bills maturing Oct. 31 soared to as high as 0.16 percent today, from 0.025 percent on Sept. 30.

Tentative Signs

“We may be starting to see some tentative signs that the current debate is affecting financial markets,” the Treasury said today. “Although the price moves are small and could easily reverse quickly, the fact that yields on Treasury bills that mature at the end of October are higher than bills that mature immediately before or after, might suggest nascent concerns about possible delays in payments on those bills.”

Concerns over the debt limit could also cause an increase in mortgage rates “that would restrain the housing market and household spending,” according to the Treasury.

The Obama administration doesn’t plan to use a constitutional amendment to get around the debt limit, and prioritizing some bills over others would be unworkable, according to a Treasury official who spoke to reporters in a conference call today. Congressional action is the only way to avoid default, said the official, who asked for anonymity as a condition for discussing the report.

The Constitution’s 14th Amendment says the validity of the public debt of the United States “shall not be questioned.” The Obama administration has previously dismissed the idea of invoking the amendment to get around the debt limit.

Economic Fallout

Postponing a debt-ceiling increase “to the very last minute is exactly what our economy does not need,” Lew said in the report.

Obama met yesterday with financial-industry executives including Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein and JPMorgan Chase & Co. CEO Jamie Dimon. Blankfein said after the meeting that lawmakers are risking the economic recovery if they don’t raise the debt limit. The meeting was part of an effort by the Obama administration to leverage the business community’s clout in breaking the stalemate.

“It’s incomprehensible, frankly, that we’re sitting here talking about the fact that the United States of America might have to sit down at its desk in a couple of weeks and decide which bills it can afford to pay,” John Kanas, CEO of Miami Lakes, Florida-based BankUnited Inc., said on Bloomberg Television today.

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