FACTBOX-The day the U.S. (technically) defaulted

July 11 Mon Jul 11, 2011 5:54pm EDT

July 11 (Reuters) - The first and only time the United States suffered a technical default 32 years ago was blamed on check-processing glitches and quickly corrected -- but did that matter to markets?

At the time, the Congress and the Carter administration were locked in a debt limit battle, that time to raise the U.S. borrowing cap to $830 billion -- compared to the now-exhausted $14.3 trillion limit.

Following are details of the 1979 incidents and their aftermath.

WHAT HAPPENED

The U.S. Treasury was forced to delay payments to individual investors redeeming about $122 million of Treasury bills maturing on April 26, May 3 and May 10, 1979. The Treasury blamed the delay on an unprecedented volume of participation by small investors and the unanticipated failure of word-processing equipment used to prepare schedules needed to cut them individual paper checks.

The problem was cleared up within three weeks, and investors holding T-bills maturing on May 17, 1979, were paid on time.

AFTERMATH

Yields on Treasury bills shot up by about 60 basis points, or 0.6 percent. A scholarly paper on the accidental defaults published a decade later argued the damage was permanent.

"This increase was a one-time, permanent ratchet upward of yields," wrote Terry Zivney, a finance professor at Ball State University and Richard Marcus, a finance professor at the University of Wisconsin-Milwaukee, in their 1989 paper titled, "The Day the United States Defaulted on Treasury Bills."

The delayed payments occurred as U.S. interest rates were soaring higher ahead of the Federal Reserve's massive tightening of monetary policy under Paul Volcker, who took over as the central bank's chairman later that year.

Prevailing 13-week bill yields in May 1979 were 9.68 percent -- a reason why so many individual investors parked money in "risk-free" T-Bills.

On Monday, however, bill yields were just 0.02 percent, indicating that much had changed since the 1989 analysis.

"What is clear from the data is that the default in early 1979 did appear to be part of the 'cause' of the well-publicized increase in interest rate levels suffered in the first half of the 1980s," wrote Zivney and Marcus.

"Perhaps too much blame for the higher interest rates has been leveled at the Federal Reserve for a change in monetary policy, where a portion of the blame should be assigned to Treasury."

TREASURY'S VIEW

The U.S. Treasury does not view the 1979 incidents as a true default. A Treasury official said it was a technical bookkeeping glitch that was rectified quickly and affected only a tiny percentage of maturing securities at the time.

It is a far cry from the default that would occur should the Congress fail to raise the debt limit before Aug. 2, when the Treasury has said it will no longer be able to pay all of the country's bills.

U.S. Treasury Secretary Timothy Geithner has argued that a default would spike Treasury yields sharply higher, choking off recovery and causing panic in world financial markets. (Reporting by David Lawder)

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