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  • From the WSJ - FAQs about impact of hitting the debt ceiling

    3 posts, 3 voices, 1490 views, started May 16, 2011

    Posted on Monday, May 16, 2011


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      Questions and Answers About Reaching the Debt Ceiling .

      With the U.S. government reaching its legal borrowing limit on Monday, here are some answers to commonly asked questions:

      Q: What is the immediate impact of reaching the debt ceiling?  

      A: For now, government services will largely continue uninterrupted. However the Treasury Department has started undertaking some technical, emergency steps to conserve cash so it can pay its bills and make payroll. It has stopped issuing certain debt for state and local governments. Among other things, it can stop payments into the Civil Service Retirement system, redeem existing investment, and stop reinvestment in the exchange stabilization fund, which buys and sells foreign currencies.  

      Q: Is this a default?  

      A: No. A default would occur after the emergency measures are exhausted and it runs out of cash to pay its bills. Treasury officials say that would occur Aug. 2, if Congress does not raise the debt ceiling before then. They say that could mean stopping or limiting not only interest payments to debt holders, but also Social Security and Medicare payments, unemployment benefits, tax refunds and money owed to government contractors.

      Q: After default, which bills would the Treasury stop paying first? How will it decide?  

      A: Treasury officials haven’t said. They and their allies say prioritizing payments is not a practical option. The government’s cash flows are lumpy—inflows of tax money and outflows of obligated payments often don’t match up neatly. That means many types of payments could be affected. And there would be lots of legal issues surrounding delays of government payments to creditors.  

      Q: Could the Treasury avoid default by making payments on debt securities, but delaying or halting other payments, thereby cutting government spending?  

      A: Some lawmakers and former Treasury officials have suggested this. But current Treasury officials view it as unworkable. They point to a recent analysis by the Congressional Research Service concluding that the federal government would have to “eliminate all spending on discretionary programs, cut nearly 70% of outlays for mandatory programs, increase revenue collection by nearly two-thirds, or take some combination of those actions in the second half of FY2011 (April through September 30, 2011) in order to avoid increasing the debt limit.”  

      Q: Can the Treasury sell government assets to raise cash to postpone the date of default?  

      A: The government owns a lot of valuable stuff it could sell, including about $400 billion in student loans, $375 billion in gold, and $142 billion in stakes of companies it rescued during the financial crisis. But the Treasury says selling off many of those assets would cost taxpayers money and could destabilize companies, markets and even the financial system. So Treasury officials have ruled this out as an option.

      Q: Does Treasury have other steps it can take?  

      A: The government has found creative ways to avoid a default in the past. Some market observers say Treasury probably can come up with more maneuvers to postpone default beyond the Aug. 2 date, but they do not project how far beyond. In 1995-96, Treasury declared a one-year debt issuance suspension period, in order to disinvest large amounts from the civil-servant fund and free up additional borrowing capacity. Some market watchers say there’s nothing obviously preventing a Treasury secretary from declaring a longer suspension—say, two years.  

      Q: How will Treasury auctions be affected during the time between touching the debt ceiling and defaulting?  

      A: Market experts don’t foresee any meaningful change in auction size or frequency between now and early August. That’s possible in part because some of the auctions are held to roll over maturing debt, and do not add to total debt. Additionally, the emergency measures hold down or even reduce the amount of intergovernmental debt. By early August, though, auctions could be delayed or decreased in size, and some experts say it’s possible that maturities would be shorter.  

      Q: Would a smaller supply of new Treasuries mean higher prices and lower yields?  

      A: Hard to know. The possibility of reduced future issues could make existing issues more valuable. But that could be undercut by fears that the whole Treasury market would be destabilized by a political standoff.  

      Q: What happens in the case of default?  

      A: It has never happened in modern times, so it is difficult to predict. Treasury says it could cause another financial crisis and economic recession. The value of Treasurys used as collateral in contracts would plummet, and yields—which move the opposite direction—would rise. Because Treasury yields are used as the benchmark for other interest rates, consumers and businesses would face higher rates for mortgages, credit cards, car loans, student loans, and commercial credit. Some observers have questioned the dire predictions.

      Q: Can’t the Federal Reserve just bail out the Treasury?  

      A: No. The Fed can’t lend money to the Treasury.

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