What if the debt ceiling debate causes the U.S. to miss just a couple of interest payments, say for the months of August and September? As long as the Treasury resumes payments in October, then no harm done, right? This misconception was put to rest by the rating agency Fitch in a statement yesterday. The firm makes clear that there’s effectively no such thing as a temporary default: the nation’s rating will not quickly bounce back.

At this time, the Treasury is already taking “extraordinary measures” to meet its debt obligations, since the debt ceiling needed to be raised in May. In August, those extraordinary measures won’t be enough, and the Treasury must prioritize debt payments above its other obligations to avoid default. At that time, the U.S. will be in “technical default” even if it doesn’t miss a payment.

But if the Treasury is forced to (or chooses to) skip a debt payment at that time, serious consequences will follow. If that occurs, real, tangible, lasting harm to the U.S. economy will follow. In past weeks, the rating agencies Moody’s and Standard and Poor’s have both cautioned that the debt ceiling fight could have serious consequences. But no warning has been quite as clear as that issued on Wednesday by Fitch. Walter Brandimarte at Reuters reports:

“Even a so-called ‘technical default’ would suggest a crisis of ‘governance’ from a sovereign credit and rating perspective,” Fitch said in a statement.

“Clearly the political signals which are coming (from Washington) are a source of concern,” David Riley, head of sovereign ratings at Fitch, told Reuters in an interview.

Treasury bonds could be rated “junk” by Fitch Ratings if the government misses some $82 billion in debt payments by Aug. 15 due to disagreement over the debt ceiling.

The ratings would go back up once the government fulfills its debt obligations but probably not to the current AAA level, Fitch said.

Technical default would worry the agencies, but a missed payment would result in disastrous consequences. That wouldn’t be a temporary problem: Treasuries will not revert back to their AAA-status immediately after the debt ceiling is raised.

According to a report yesterday, a number of mainstream Republicans now openly embrace the possibility of technical default. As explained here about a month ago, Republicans may see default as positive, in a sense. It carries their “starve the beast” strategy to the extreme. The beast — that is, the federal government — will be forced to begin consuming its own flesh, and a diet — spending cuts — will inevitably follow.

But it also pushes the Treasury into crisis mode and puts the nation on the brink of missing an interest payment. While the Obama administration will likely prevent that from happening for as long as possible, Republicans must have a lot of faith that it’s both willing and able to do so indefinitely.

If an interest payment is missed, the U.S. will have more expensive debt for years, until it manages to convince the agencies to restore its top rating. For that time period, it will be even harder for the U.S. to get its fiscal house in order, because some of its tax revenue that could have been used to pay down debt will instead have to go towards higher interest payments than would have been required on AAA-rated debt.

In other words, taxes would have to be even higher to pay down the debt. Surely, Republicans don’t want that. While they might argue that they could just cut spending more aggressively, there may come a point at which even Republicans become uneasy cutting too deep into popular entitlement programs like Social Security and Medicare.

These messages from the rating agencies should encourage Congress to work harder and for each side of the debate to give a little more up to reach a compromise quickly. A default is in no one’s best interest.

The Atlantic

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