RALEIGH – With the question of raising the federal debt ceiling unresolved, there are increasing concerns about what would happen if interest payments on the national debt were not made. To understand what this might mean, think of this analogy.
What if you are purchasing your home by using debt – commonly called a home mortgage. You are expected to make a monthly payment to your lender. Each payment includes part that reduces your debt, and part that pays interest on what you borrowed.
Mike Walden (NCSU photo)
What would happen if you stopped making those payments? Clearly, your lender would not be happy because you promised to make those regular payments. The lender might give you a few months of grace, but if the nonpayment goes on for too long, the lender could ultimately take possession of your home and kick you out. Or, if not this, you would amass large penalties and a reduction in your credit rating. The next time you tried to borrow money, you would pay through the nose!
When our federal government borrows money, it promises to make regular interest payments to the lender (the amount borrowed is actually paid at the end of the term of the debt – possibly as long as 30 years). If the federal government doesn’t have the money to make all the interest payments, then it has reneged on its promise.
Now, unlike a home borrower, holders of federal debt can’t take over the federal government if interest payments aren’t made. Instead, the federal government will be “punished” in another way. On future debt offerings, the federal government will likely have to pay much higher interest rates to convince anyone to lend them money. This means federal borrowing costs in the future will be higher, which also means other federal spending will need to be cut, or taxes will have to be raised. Therefore, all of us would feel those effects.
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But the ramifications don’t stop here. Private sector interest rates, like those for home loans, car loans, personal loans, and business loans, are indirectly tied to the interest rate the federal government pays to borrow. If the federal interest rate goes up, so too will all these other interest rates. We all would pay more for borrowing funds.
But higher interest rates usually mean people and businesses will borrow less, and as a result, the economy slows. We’re seeing that now with the higher interest rates engineered by the Federal Reserve. The jump in interest rates prompted by a federal default would be on top of the Federal Reserve’s hikes. Some economists are predicting the effect of this double-barreled rise in rates would ensure a recession, and it would be a bad recession.
There are several forecasts predicting the loss of millions of jobs in a downturn after a federal government default.
This is why many observers think the debt limit impasse will be solved – that there will be a deal to raise the ceiling in exchange for some moderation in future federal spending. The deal may come at the very last minute – or second – but the thought is that no political leader wants to be the first to oversee a possible default on federal debt. Yet, if no deal is reached and a default does occur, brace for a reaction that would be a first, and would be very bad.
