With negotiations on raising the debt ceiling bogging down on Friday, the U.S. may be less than two weeks from defaulting on its debt, an unprecedented scenario that government officials have variously described as “unthinkable” and potentially “catastrophic.”
A default would mean the U.S. government fails to pay some of its obligations because the Congress failed to raise the debt ceiling to authorize borrowing more money to fund spending it already passed. Its impact would be felt by anyone expecting funds from the government, whether a Social Security check, SNAP payment, a government bond payout or — in the case of federal employees — a paycheck.
“Most state economies will be hit hard if there is a debt limit breach, although the economic pain varies,” economists at Moody’s Analytics said in a report analyzing the possibility of a default.
Public sector takes a hit
Washington, D.C., where 1 in 4 jobs are tied to the federal government, would be hardest hit, becoming the “poster child” for a financial disaster, they said. States with large federal facilities, such as national laboratories or military bases, would be next in line. That includes Hawaii, which is home to the United States Pacific Command and to 11 military bases; Alaska, with vast federal land holdings; and New Mexico, home to Los Alamos National Laboratory.
“While the public sector typically serves as a stabilizing force, in the case of a breach it supercharges its economic fallout,” wrote Moody’s Analytics economists Mark Zandi, Adam Kamins and Bernard Yaros.
Also vulnerable are regions that rely heavily on federal spending, including those with defense contractors. “Professional services firms suffer, hurting white-collar support firms in and around the Beltway, particularly Northern Virginia,” Moody’s said. “Aerospace is also hurt, impacting states including Connecticut, Kansas and Washington.”
Even a short debt ceiling breach, in which the government defaults for less than a week before lawmakers raise the government’s borrowing limit, would likely push the economy into a recession, according to Moody’s. In this scenario, 1.5 million people would lose their jobs, pushing unemployment from its current rate of 3.4% to 5%, while nation’s gross domestic product would shrink by 0.7%.
Federal employee may go unpaid
As Treasury Secretary Janet Yellen noted, federal employees and contractors may show up to work not knowing if they’ll get paid. That creates a precarious situation in Washington, D.C., where more that a quarter of employees work for the federal government.
But it also would have reverberations across the nation. That includes many small rural counties, which where many local residents are employed by the federal government in agencies such as the U.S. Forest Service.
The top 20 counties with high numbers of federal employees represent a large swath of the nation, including states in the South, West and Midwest. There are 45 counties where at least 1 in 20 residents is a federal employee.
Moody’s also assesses the potential damage from a default lasting several months, an outcome it said would be “cataclysmic.” The federal government would have no option but to slash its spending by about $150 billion. “As these cuts work through the economy, the hit to growth would be overwhelming,” Moody’s said.
“The economic downturn that would ensue would be comparable to that suffered during the global financial crisis,” with nearly 8 million jobs lost and the unemployment rate rising to 8%, according to the financial research firm. In this scenario, several states would suffer disproportionately, with Moody’s estimating that unemployment would top 9% in Alabama, Illinois, Ohio and Mississippi, while shooting up to nearly 11% in Michigan.
The turmoil would also likely depress stock prices by nearly 20%, vaporizing $10 trillion in household wealth held in 401(k) plans, pension funds and brokerage accounts, according to Moody’s. The cost of borrowing for households and businesses would soar.
Because of the enormous economic fallout of a debt default, it’s worth noting that Moody’s considers such an outcome highly unlikely. And if there is a breach, it’s likely to be short.
“But even a lengthy standoff no longer has a zero probability,” the analysts said. “What once seemed unimaginable now seems a real threat.”