U.S. default could prompt new recession: study

WASHINGTON Fri May 13, 2011 12:27pm EDT

A ''For Sale- Bank Owned'' sign sits in front of a home in Pontiac, Michigan June 19, 2009. REUTERS/Rebecca Cook

A ''For Sale- Bank Owned'' sign sits in front of a home in Pontiac, Michigan June 19, 2009.

Credit: Reuters/Rebecca Cook

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WASHINGTON (Reuters) - The United States could plunge back into recession if inaction in Washington forced a debt default, according to a new analysis that arrives as the country reaches the legal limits of its borrowing authority.

Some 640,000 U.S. jobs would vanish, the housing market's woes would deepen, stocks would fall and lending activity would tighten if the country were unable to pay its bills, according to a report by the centrist think tank Third Way due out on Monday.

The Treasury Department is expected to hit its $14.3 trillion borrowing limit on Monday, making it unable to access the bond markets again. Lawmakers from both parties say they won't approve a further increase in borrowing authority without steps to keep debt under control.

But observers do not expect a deal to emerge for several months.

The Treasury Department says it can stave off default until August 2 by drawing on other pots of money to pay its bills.

Treasury officials have warned of "catastrophic" consequences if Congress does not approve a further debt-ceiling increase by then, but have declined to say exactly what would happen.

The Third Way report, based on a survey of existing economic research, spells out the details:

* Treasury bonds would lose their aura of safety, leading to a half-point increase in their interest rates. That would push up the U.S. government borrowing cost once lending activity resumed, leading to a $10 billion increase in annual budget deficits over the short term.

* The higher interest rates would ripple through the economy, causing gross domestic product to decrease by 1 percent and employers to shed 640,000 jobs.

* Banks would curtail lending. Small businesses would have a harder time expanding and credit-card interest rates would rise. Student loans and car loans would become more expensive.

* The S&P 500 stock index would lose 6.3 percent in value over three months, causing retirement portfolios to shrink, the report said, citing research by financial services firm Janney Montgomery Scott.

* The U.S. dollar's status as the world's reserve currency could be threatened as investors move cash to Swiss francs, Japanese yen, or Euros. That could boost U.S. exports but raise the cost of consumer goods like gasoline and electronics.

* Home mortgage rates, which are tied to U.S. Treasury rates, would rise. Homebuyers taking out an average mortgage for a new home, currently $221,900, would pay an extra $24,738 over the life of the loan, dealing another blow to an already struggling housing market.

"Defaulting on our debt is not an abstract idea that might affect a few institutions on Wall Street; it would harm tens of millions of Americans in profound and lasting ways," the report says.

(Editing by Philip Barbara)

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Comments (6)
txgadfly wrote:
We need a constitutional amendment requiring an affirmative direct vote of the public to increase Federal borrowing. They just will not voluntarily stop otherwise. The only thing the two parties disagree on is where to blow the newly borrowed money.

Neither of them will even talk about where that vast majority of the deficit is wasted — supporting current Israeli policy. What a rip off.

May 13, 2011 1:07pm EDT  --  Report as abuse
NobleKin wrote:
The Republicons want the financial uncertainty to continue. A second recession in order to gain the White House is a trade off they would gladly take.

The problem is at what cost?

The longer the economy drags, the wider the deficit gap will get.

The time is now for raising taxes on the wealthiest among us. Our tax history in America demonstrates the success of this wisdom since WWII.

Millionaires will still be millionaires…


May 13, 2011 1:17pm EDT  --  Report as abuse
I am pretty sure you could argue that it is our government spending, not just tax cuts that have gotten us to this point. As much as you want to point the finger at one party, it is really both parties that brought us here. As for raising taxes on the wealthiest, I think it makes more sense to raise taxes all around, but I certainly agree that taxes will have to be raised in some form to help us dig ourselves out. However, I would first put the responsibility on the government to prove to me that our spending was going to be significantly reduced before I jumped completely on the raise the taxes bandwagon. As for the Patriotic Millionaires site you referenced, a $1M/year seems like a better starting point than the 250k/year, but I felt their argument had flaws in it as well that they never really addressed or decided to ignore.

May 13, 2011 3:32pm EDT  --  Report as abuse
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