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Lots of pain if debt ceiling isn't raised

President Barack Obama meets with congressional leaders in

President Barack Obama meets with congressional leaders in the Cabinet Room of the White House. (July 14, 2011) Photo Credit: AP

Higher interest rates on credit cards and mortgages, another spike in gasoline prices and loss of retirement savings are among the possible consequences on Main Street if Washington doesn't agree on raising the U.S. borrowing limit.

The federal government routinely spends more money than it takes in and therefore must borrow to pay all of its bills. However, Uncle Sam can no longer issue more bonds without President Barack Obama and congressional Republicans first agreeing to raise the $14.3-trillion debt ceiling.

Unlike in the past, hiking the borrowing limit this time around has become a political standoff over larger issues of taxation and spending. Economists said Obama and congressional leaders risk throwing the economy back into recession if agreement isn't reached by Friday, the deadline needed to get legislation through Congress by Aug. 2.

The United States has never before failed to honor its obligations. So, inaction by the negotiators would shock the global financial system -- even if the government manages to repay loans by cutting expenses elsewhere.

A failure to agree on the debt limit would produce a cascade of effects that are immediate and widespread, experts said.

"It would be like the financial crisis all over again . . . There would be another recession," said Gus Faucher, macroeconomics director at the forecasting service Moody's Analytics. "Many would be impacted, from consumers and federal workers to investors and small-business owners."

If the borrowing limit is not raised, economists predict the first-ever downgrading of the nation's superior AAA credit rating, which could alarm foreign investors and cause many to demand far higher interest payments on U.S. bonds. This in turn would raise interest rates for consumers and businesses using credit.

Prices for gasoline, cars and other imported goods would likely rise because the value of the dollar would fall. There also could be a big sell-off on Wall Street, where many have invested their 401(k) retirement plans.

Still, Kevin Logan, chief U.S. economist at HSBC Securities, said, "the debt ceiling will be raised in time . . . Agreement on deficit reduction could be postponed while the debt ceiling is raised temporarily, say for a few months, giving Congress more time to negotiate."

Predictions of the ramifications for consumers and businesses if there is no deal vary widely because the country hasn't been here in modern times. These are the best guesses of several fiscal experts:

JOBS

Unemployment, still high two years into an economic recovery, would likely edge up as Uncle Sam lays off workers whose wages it could no longer pay. In turn, businesses could postpone hiring, and those with government contracts, such as aerospace and software companies, may idle workers.

The private sector also would probably not hire if loans became costly. And credit already is very difficult to come by for small business, which create most of the jobs.

“The biggest problem we have is confidence... businesses and consumers aren’t convinced the worst is over for the economy and failure to raise the debt ceiling only confirms their fears,” said Patrick J. Socci, dean of Hofstra University’s business school.

Health care, one of the few sectors adding jobs, would be hit hard by reduced payments for Medicaid and Medicare, federal programs serving the poor and elderly, respectively.

CONSUMERS

Shoppers make fewer trips to the mall if they’ve lost a job or their neighbor has. And higher prices stemming from a decline in the U.S. dollar would make even people with secure employment reluctant to spend.

This pullback could cause a recession and shedding of jobs because consumer spending accounts for about 70 percent of economic activity, Socci said.

The dollar would lose value, which always makes crude oil more expensive. In fact, oil prices would likely hit record highs as foreign producers demanded payment in a mix of currencies once their faith in the U.S. dollar has been so shaken.

Richard L. Kaplan, an expert on taxation and retirement benefits at the University of Illinois in Urbana-Champaign, said, “It’s going to cost more to fill up your tank or buy anything made with petroleum products. And that means you will spend less on a vacation and other nonessential items or forgo them altogether.”

CREDIT

A failure to raise the debt limit would hike interest rates on credit cards and make them much more difficult to get. First, the rating agencies could downgrade Washington’s credit, forcing it to give higher rates to investors to entice them to buy Treasury bonds, said Esmeralda Lyn, vice dean of Hofstra’s business school. Banks then would probably see their cost of borrowing go up and in turn pass along the expense to customers in the form of higher credit-card rates.

“Interest rates would go up across the board because of the devaluation of the American dollar and essentially the loss of confidence by the world in the American dollar,” said Anthony Sabino, a St. John’s University law and business professor and Mineola attorney." It will hit so many Americans in their wallet and that’s one of the reasons when we get down to the 11th hour and the 59th minute they will do a deal.”

STOCKS

The specter of the United States not being able to meet its financial obligations, no matter how unlikely, would drive down stocks. The sell-off could be far worse than the jitters seen in recent days over Europe’s fiscal crisis.

Stocks could plunge between 20 percent and 30 percent, according to some economists. Such a slide would wipe out the gains made by 401(k) plans, which only recently recouped their losses from the 2008 financial meltdown.

“There would be a big plunge in the stock market... It would be a disaster,” Faucher said.

Nearly 60 percent of 401(k) money is invested in equities, so any sell-off would likely postpone the retirements of many, particularly Baby Boomers who, unlike their parents, generally lack traditional, fixed pensions.

Faucher said: “Their plans would have to change. They couldn’t afford to stop working.”

MORTGAGES

House hunters shopping for mortgages and some borrowers with adjustable rate loans could be hit with rising interest rates. Usually, bad news, such as high unemployment, drives borrowing costs down — but not this time.

Warren Goldberg, a Woodbury-based mortgage broker with GuardHill Financial Corp., predicted mortgage shoppers would see higher rates right away. However, if the federal government misses paying its bills only for a couple of weeks or a month, borrowers with adjustable rates probably wouldn’t be affected unless their rates are scheduled to change next month or in September, he said.

Rates have been going up or down by a fraction of a percent per week, but economist Lawrence White, of New York University’s Stern School of Business, said they could jump 1 percentage point the week the nation doesn’t honor all its obligations.

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