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Evidence of the Consequence of Default

WaPo points to a study about a quasi-default back in 1979:  Delayed payments in 1979 offer glimpse of default consequences.

The background:

there was one short-lived incident in the spring of 1979 that offers a glimpse of some of the problems and costs that might arise if the stalemate on Capitol Hill continues. Then, as now, Congress had been playing a game of chicken with the debt limit, raising it to $830 billion – compared with today’s $14.3 trillion – only after Treasury Secretary W. Michael Blumenthal warned that the country was hours away from the first default in its history.

That last-minute approval, combined with a flood of investor demand for Treasury bills and a series of technical glitches in processing the backlog of paperwork, resulted in thousands of late payments to holders of Treasury bills that were maturing that April and May.

“You hear lot of people say, ‘The government never defaulted.’ The truth is, yeah, they did . . . It might have been small, it might have been inadvertent, but it happened,” said Terry Zivney, a finance professor at Ball State University who co-authored a paper on the episode entitled “The Day the United States Defaulted on Treasury Bills.”

The consequences:

the study by Zivney and his partner, Dick Marcus, found that even that brief failure to meet some obligations had expensive consequences. The pair concluded “that the series of defaults resulted in a permanent increase in interest rates” of more than half a percent, which over time translated into billions of dollars in increased interest payments on the nation’s debt, a cost shouldered by taxpayers.

“The impact is smaller at first because only new debt is affected,” they wrote. “But over time, as the older debt matures and becomes refinanced at higher rates, the entire cost of the default is realized.”

And the relative comparison to the current situation?

Zivney said that the 1979 incident, which pales in comparison to the size and scope of payments the Treasury could have to forego if it can no longer borrow money come Aug. 2, offers a useful case study in the real-world consequences that result when the U.S. government doesn’t seem like the sure bet it has always been.

“It creates doubt, and I think that’s the real lesson,” he said. “The market has a much longer memory than individuals.”

Angel, the Georgetown professor, said that the surest way to stave off any such doubts is for Congress to find a way to set aside political fights long enough to ensure that the country continues to pay its bills. Otherwise, he said, investors will punish the United States – and ultimately taxpayers – if and when checks stop showing up.

“It’s not as if God appeared to Moses on Mount Sinai and said, ‘The U.S. will always be a AAA credit.’ Our reputation is something that we have earned,” Angel said, adding that history is filled “with countries that were once great and blew it. The simple lesson is, you’ve got to pay your bills on time. If you don’t pay your bills on time, bad things happen.”

And yet, we continue to play with fire.  I would like to think that all of the rhetoric in Washinton over this issue is just words being used for leverage, but I have my doubts.  My ultimate assumption is that the Congress will do the right thing and raise the debt ceiling, but listening to some members of Congress, such as Senator DeMint, I wonder if the main actors involved in this situation understand what they are talking about.

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About Steven L. Taylor
Steven L. Taylor is Professor and Chair of Political Science at Troy University. His main areas of expertise include parties, elections, and the institutional design of democracies. He is the author of Voting Amid Violence: Electoral Democracy in Colombia and is currently working on a comparative study of the US to 29 other democracies. He earned his Ph.D. from the University of Texas and his BA from the University of California, Irvine. He has been blogging at PoliBlog since 2003. Follow Steven on Twitter

Comments

  1. James says:

    I am shocked, shocked that forcing the United States to default for political purposes might have negative consequences.

    One point that I think is often lost in the debt ceiling coverage/debate is that, as Jonathan Bernstein points out:

    before the deadline or after, sooner or later the debt limit will go up. Which means that sooner or later, a majority of the House is going to vote to raise the debt ceiling. So will a majority of the Senate — quite possibly, a filibuster-proof majority. And the Barack Obama is going to sign it.

    It’s going to happen at some point. The question is when, and how much financial damage are we going to inflict upon ourselves in the meantime.

    Like or Dislike: Thumb up 0 Thumb down 0

  2. The most interesting thing here is noting that the national debt has doubled more than four times and then some in 32 years since its increase to $830B.

    Why do so many people think that servicing the debt must be first in line to be not paid?
    As should be clear from the weekends events, the WH is not negotiating in good faith so just raising the debt limit is only going to make things bad as well, albeit in a different way. It has been said that admitting you have a problem is the first step in any recovery problem and yet the WH continues to act as though debt in and of itself is not a problem. They are wrong.

    I believe the debt limit will be raised soon, but not by very much. The only thing we can reliably predict will happen is that the emotional stops will be pulled and we will hear nothing from Big Media but how these cuts are going to hurt somebody.

    Like or Dislike: Thumb up 1 Thumb down 6

  3. Hey Norm says:

    Hmmmm…should I pay attention to history and experience and people who study such things…or Jim DeMint and Bachmann and the rest of the Tea Party?
    Decisions, decisions.
    It is heartening to see Austin interpret Boehner backing away from the table as the WH not negotiating in good faith. I like consistency, even if it’s consistent befuddlement.

    Like or Dislike: Thumb up 1 Thumb down 1

  4. Hey Norm says:

    Important to note:
    Nothing being discussed at the “table” will help the real crisis we face – demand, and thus unemployment. In fact any deal made will result in a net loss of jobs.

    Like or Dislike: Thumb up 1 Thumb down 1

  5. James says:

    @charles austin:

    Why do so many people think that servicing the debt must be first in line to be not paid?

    Who are these people? Can you link them?

    As should be clear from the weekends events, the WH is not negotiating in good faith

    How is this clear? John Boehner just dropped out of a potential $4 trillion debt deal over insistence on zero new taxes.

    the WH continues to act as though debt in and of itself is not a problem.

    Huh? By frantically trying to cut a deal that combines something like 85% spending cuts to 15% revenue increases? The exact same ratio espoused by the Republicans on the Joint Economic Committee ?

    Like or Dislike: Thumb up 7 Thumb down 1

  6. Don L says:

    Default is much like divorce -the fact is that the marriage and trust was already over with before it got to the technical reality. We have already defaulted in the minds of many – printing billions is a form of default, paying debt with funny money has a way of saying default.

    Spending trillions we dont have is in reality, a form of default by due bill. Maybe when the real thing comes, it might prove to be a catharsis.

    Like a drunk hitting bottom, better default now than the charade of more unsustainable spending. Giving short term Band-aides now is just another way of finding another bottle of booze.

    Like or Dislike: Thumb up 1 Thumb down 5

  7. James and Hey Norm, read this from the right or this from the left for evidence of the WH’s bad faith. Or don’t and keep your fingers in your ears singing la-la-la as we go over the cliff. Where exactly has Obama been the last two and half years to suddenly realize this has to be dealt with, or should I say dealt with his way or the highway. Perhaps he forgot that Boehner won the last election, not him.

    As to links you asked for, I suggest anyone who thinks not raising the debt limit immediately leads to a default qualifies. We’ve been down the path before of actual tax increses and promised spending cuts. They lied.

    Hey, let me guess which two people didn’t like my comment. The echo chamber is strong in these two.

    Like or Dislike: Thumb up 1 Thumb down 3

  8. James says:

    @charles austin: I’m not going to spend to much time on your “bad faith” argument because well, you don’t have an argument. You just have two unrelated links; one is a Yuval Levin op/ed for NR and the other a Globe puff piece about the political unpopularity of increasing federal revenues via-a-vis eliminating tax credits.

    This quote here though, honestly confuses me:

    anyone who thinks not raising the debt limit immediately leads to a default qualifies.

    Huh? “Qualifies” as what?

    And then you write

    We’ve been down the path before of actual tax increses and promised spending cuts. They lied.

    When was this? Who lied? Do you mean the Omnibus Budget Reconciliation Act of 1993 signed by Bill Clinton? The one that, among other things, raised the top marginal rate from 36% to 39.6%, and helped create one of biggest budget surpluses in the history of the United States?

    And then there’s this little gem:

    The echo chamber is strong in these two.

    I believe the term is “projection

    Like or Dislike: Thumb up 1 Thumb down 1

  9. The arguments about raising the debt level seem to me nothing more than a variant of someone who is in way over their head thinking that as long as they can meet the monthly minimums on their credit cards then there’s no real problem.

    james (not joyner), Bush I. I even mentioned it recently. Look it up.

    Like or Dislike: Thumb up 1 Thumb down 1

  10. james (not joyner), and you — and others who parrot these same memes — conveniently fail to note that those balanced budgets in the Clinton years didn’t come until several years later after spending reductions materialized in other bills to riegn in spending as well as raising taxes.

    But hey, you guys can goon it up and dislike my comments now rather than respond to them, not that I’d call your responses, well, responses, so, whatever.

    Like or Dislike: Thumb up 1 Thumb down 1

  11. @charles austin:

    conveniently fail to note that those balanced budgets in the Clinton years didn’t come until several years later after spending reductions materialized in other bills to riegn in spending as well as raising taxes.

    So, you are saying that fiscal balance can come about through a prudent mix of tax increases and spending cuts?

    Like or Dislike: Thumb up 3 Thumb down 1

  12. Dr. Taylor, yes, along with counting Social Security taxes as general revenue. Let’s not forget that little bit of accounting dishonesty as well.

    And here’s James Pethokoukis with more details highligting the bad faith of the WH in these negotiations. From my perspective, suddenly deciding that the government needs to be 20% larger than what it had been for the last 60 years or so is a bit more radical than I would like.

    Like or Dislike: Thumb up 1 Thumb down 1

  13. Dr. Taylor, and let’s also not forget the dot com bubble which Clinton’s budgets benefited from with the bills coming due on Bush’s watch, not to mention the beginning of the Fannie Mae and Freddie Mac follies which took a few more years to blow up in our faces.

    Like or Dislike: Thumb up 1 Thumb down 1

  14. @charles austin: You’re right: it is all so simple: the Democrats are bad and the Republicans are good. It really has nothing to do with general public demands or the structure of our politics.

    Like or Dislike: Thumb up 2 Thumb down 0

  15. OzarkHillbilly says:

    and let’s also not forget the dot com bubble which Clinton’s budgets benefited from with the bills coming due on Bush’s watch

    but let’s do forget 2 unfunded wars, a massive expansion of defense spending, a massive and unfunded expansion of Medicare, and 2 massive tax cuts under Bush….

    You do have a rather selective memory Charles.

    Like or Dislike: Thumb up 4 Thumb down 0

  16. Dr. Taylor, I don’t think that’s what I said at all. If anything I would say Republicans bad, Democrats worse on this topic. As has been noted in these pages before, our body politic is broken for several reasons. I would put near the top the disconnect between demands and the necessity and responsibility for paying for them, buying off 51% of the popluation with the money from the other 49%, etc. but YMMV. We are going bankrupt (if we are not already there) and our two political parties are moving further and further apart, due primarily, though not exclusively to gerrymandering over the years, making it even harder to reach a consensus for governing.

    I’m thrilled to see some Republicans at least paying lip service to fiscal sanity, but I fear it is still just lip service and the appetite to bring spending under control isn’t strong enough in them either whereas it is virtually nonexistent on the Democrat side of the aisle. So, I’ll happily accede to believing Democrats are worse than Republicans but resist saying it is as simple as Republicans good, Democrats bad. What I cannot abide is the idea that Republicans and Democrats are merely the two sides of the scale and if only they would meet halfway everything would be wonderful again.

    Like or Dislike: Thumb up 0 Thumb down 1

  17. tom p, I call bullshit. I have been a vociferous critic of Bush’s so-called compassionate conservatism, aka, let’s spend link Democrats but just administer it a little better. Fell free to look up my comments at the time about the Prescription Drug Program or No Child Left Behind. I’ll also note that Bush’s two wars have become Obama’s six wars, but the devil is in the details. Oh, and look, Guantanamo is still open too.

    My point was that it was a fortuitous confluence of events and accounting gimmicks if not outright lies, that led to two years of balanced budgets and nothing so simple as the tax increases of 1993.

    Like or Dislike: Thumb up 0 Thumb down 1

  18. James says:

    @charles austin: If you want better comment ratings, write better comments. Because so far, you’ve basically been writing up a bunch of word salads.

    Now, if you’ve got an idea or a plan to help make the United State’s public debt more manageable, I’m open to reading it. But so far you’ve just whined about how awful our political system is and how bankrupt the parties are. Resentment makes great politics, but terrible goverment.

    Like or Dislike: Thumb up 2 Thumb down 0