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All could feel pain of US default

Nation’s creditors would be paid first

By Donovan Slack
Globe Staff / July 14, 2011

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WASHINGTON - If there is any consensus on what would happen if Congress does not vote to raise the debt limit by Aug. 2, it’s this: Creditors would get the first crack at the few billion dollars left in the federal coffers.

That’s because no one in the government, not even Tea Party Republicans who vociferously argue against raising the limit, wants to damage an already staggering world economy.

Failing to pay what is owed holders of Treasury bills, bonds, and other investments tied to the US government could cause catastrophic short-term problems, such as the credit market freezing as fearful banks refuse to loan money. Long term, any failure to meet these obligations would drive up costs of borrowing, adding hundreds of billions of dollars to the deficit.

“Treasury is not going to let the country default,’’ said Jay Powell, speaking specifically about these obligations to pay investors in the nation. Powell was undersecretary of the treasury for finance for President George H.W. Bush, and is now a visiting scholar at the Bipartisan Policy Center, a Washington-based think tank.

Testifying before Congress yesterday, Federal Reserve Chairman Ben Bernanke was emphatic on that point. “Failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy,’’ he said.

For those next in line to receive money due from the government, the future is much murkier. On Aug. 3, some $23 billion in Social Security checks are scheduled to be sent, as are $2.2 billion in Medicare and Medicaid payments, and $1.4 billion in food stamps, welfare cash assistance, and unemployment benefits, according to an analysis of federal cash flow and invoices by the Bipartisan Policy Center.

President Obama and Treasury Secretary Timothy Geithner have both said they cannot guarantee recipients will receive those Social Security checks, money that millions of the nation’s seniors and disabled depend upon.

The government has never failed to pay those benefits before, although it has come close. In February 1996, Treasury had reached its debt limit and did not have enough money to pay Social Security benefits in March of that year. Congress, which has limited power to let Treasury borrow money that does not count toward the debt limit, passed stopgap measures allowing the agency to raise enough to cut the checks that month. A permanent agreement to increase the limit was soon reached.

Yesterday, Senator Bill Nelson, Democrat of Florida, introduced a bill that sought a similar exemption. But its prospects in this bitterly divided Congress are uncertain, at best.

Some analysts and legislators held out hope that Social Security recipients would be near the top of the payment list.

“The chances that Social Security wouldn’t be paid are very remote,’’ said Jennifer Duffy, senior analyst at the nonpartisan Cook Political Report. “Both parties understand that seniors live on this money, and they will find a way to make it happen. This is not to suggest there might not be a delay.’’

The president met with congressional leaders at the White House for the fourth straight day yesterday in an attempt to craft a compromise that would mandate long-term spending cuts in exchange for a vote to raise the debt limit. The meeting, which lasted nearly two hours, was the most tense to date.

The White House has said a deal should be reached by July 22, to give congressional committees an opportunity to review and vote on it.

As the leaders were meeting, Moody’s Investors Service warned that it would downgrade the US credit rating if the debt limit is not raised. Such a change would greatly increase the cost of borrowing. Since 1917, when it first offered ratings on US government debt, Moody’s has given the nation its top rating.

Economists say the markets could begin a spiral long before Aug. 2, just on fear that Congress may not act in time.

“As everybody knows, it doesn’t take much to spook the financial markets,’’ said Randy Albelda, an economics professor at the University of Massachusetts-Boston. “The fear of not paying back the debt or the possibility of that, it doesn’t matter whether we do it or not, it’s the fear that will shake the financial markets.

“Wall Street folks are already . . . saying, ‘don’t play chicken and get in a car wreck with our economy,’ ’’ she said.

In all, the government is scheduled to pay out $307 billion between Aug. 2 and 31, but it will take in only $172 billion, according to the Bipartisan Policy Center. The Washington-based think tank seeks to promote bipartisanship and offers analysis on key subjects before Congress.

The largest expense is Social Security, at $49 billion. Interest on the nation’s current debt will cost $29 billion. After that, the government faces a host of commitments, from paying the salaries of service members in Afghanistan to making good on contracts for companies working on federal highways.

Bernanke confirmed for the first time yesterday that the administration is making contingency plans that would prioritize who would get paid.

“Just as a matter of arithmetic fairly soon after that date there would have to be significant cuts in Social Security, Medicare, military pay, or some combination of those in order to avoid borrowing more money,’’ he said.

On the matter of service members’ pay, some Tea Party-backed Republicans vowed to take preemptive action. Representatives Steve King of Iowa and Michele Bachmann of Minnesota, a 2012 presidential candidate, revealed legislation yesterday that would require the government to pay interest on debts and military salaries first.

Bachmann believes Obama and Geithner have been disingenuous by saying that failure to raise the debt limit could lead to default on what is owed creditors. “We cannot go on scaring the American people,’’ said Bachmann, who noted that she will not vote for a debt limit increase.

The Treasury considers not paying any obligations a default.

“Adopting a policy that payments to investors should take precedence over other US legal obligations would merely be default by another name, since the world would recognize it as a failure by the United States to stand behind its commitments,’’ the agency said in a statement. “It would therefore bring about the same catastrophic economic consequences.’’

Powell, of the Bipartisan Policy Center, said that without a deal, once interest payments are made, “it’s anybody’s guess’’ what comes next.

Donovan Slack can be reached at dslack@globe.com. Follow her on Twitter @DonovanSlack.