Money

Looming Catastrophic Default Would Make Lehman’s Fall Look Miniscule

| by Sarah Fruchtnicht

The impending government default would cause an economic catastrophe that would dwarf the impact of the Lehman Brothers Holdings collapse of 2008.

With a default hanging over their heads, investors are already weary. On Monday the value of the U.S. dollar fell sharply against other major currencies. The Dow Jones industrial average was down 132 points this morning. When Lehman filed for bankruptcy on Sept. 15, 2008, the Dow closed down just over 500 points.

If the world’s largest borrower is unable to pay its debt on Oct. 17, a $5 trillion lending cycle will halt, according to Bloomberg. Referred to as a “financial apocalypse,” a default means the cost of borrowing will explode for individuals and companies, the dollar will plummet, and the U.S. and world economies will face another recession. 

Treasury secretary Jacob Lew wrote to Congress in September attempting to explain how doomed the market would be in the event of a default.

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"The debt limit impasse that took place in 2011 caused significant harm to the economy and an unheard of downgrade to the credit rating of the U.S.,” Lew wrote. “The drawn-out dispute caused business uncertainty to increase, consumer confidence to drop, and financial markets to plunge. If Congress were to repeat that brinksmanship again this time, it could inflict even greater harm on the economy. And if the government should ultimately become unable to pay all of its bills, the results could be catastrophic.”

“If it were to occur – and it’s a big if – one would expect a series of legal triggers, potentially transmitting the default to many other markets,” Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., told Bloomberg. “All this would add to the headwinds facing economic growth. It would also undermine the role of the U.S. in the world economy.”

“And default would be an inexpressibly stupid event,” added John Waggoner of USA Today.

The U.S. government debt is $12 trillion, 23 times that of Lehman in 2008. While the Treasury should have $30 billion in cash on hand Oct. 17, the money will be gone in a heartbeat, Lew said. Government payment typically reach $60 billion in one day.

“I'm telling you that on the 17th, we run out of the ability to borrow, and Congress is playing with fire," Lew said.

Sen. Ted Cruz, R-Texas, who led the charge on the government shutdown told CNN’s Candy Crowley on Sunday that the debt ceiling is the best leverage to eliminate spending.

“The debt ceiling historically has been among the best leverage that Congress has to rein in the executive,” Cruz said.

Berkshire Hathaway billionaire Warren Buffett has said that the debt ceiling should never be used in policy debate.

“It should be like nuclear bombs, basically too horrible to use,” Buffett told Fortune Magazine last week.

“It would be insane to default, but it’s no longer a zero-percent probability,” said Simon Johnson, Bloomberg columnist and former chief economist of the International Monetary Fund.

Sources: Bloomberg, Mediaite, USA Today