U.S. is close to technical default; downgrade possible

Quick review

I covered this in an earlier post. The U.S. reached its legal debt ceiling back in May and would normally not be allowed to keep borrowing (i.e. issuing new debt) since then.

To get around this, and to continue issuing new debt, the US government put in place “extraordinary measures” that effectively allows the Treasury to keep borrowing but not count this towards “Total Public Debt Subject to Limit”. This is just a stopgap measure.

An update

Data in this article shows the rate at which the Treasury is burning through the extra $303 billion given to them by extraordinary measures. The head of the U.S. Treasury announced today that the money will run out no later than October 17.

This is just 22 days away. The U.S. is getting awfully close to a technical default, in which they are unable to make payments on their obligations.

What could happen now?

Government could:

  1. raise the debt ceiling

  2. expand the “extraordinary measures”

  3. shut down some programs & services to save cashflow

  4. fail to make timely coupon or principal payments on bonds

Realistically, I don't think a bond default (#4) will happen. For instance CDS (credit default swaps) on US Treasuries do not show an elevated risk of default.

But we are now just 22 days – at most! – from this situation. The fact that #4 exists on this list means that the USA could actually default, and the credit rating of the USA could be downgraded to reflect this real possibility.

It's also worth noting that even if bond payments are made, the USA could still be in technical default. From the WSJ article:

... analysts believe it would only be a matter of days, or perhaps weeks, before that cash ran out and triggered what is known as a "technical default" because some payments wouldn't be met.

In the letter, Mr. Lew said Republican proposals to "prioritize" Treasury's payments after this time, such as by making interest payments to bondholders before making other payments, is "simply default by another name."

Furthermore, it does not inspire confidence that this endgame is occurring so frequently. Over time, America is proving itself to be a less creditworthy borrower.

- Perpetual Bull,