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U.S. Debt Default: How Would It Affect You?

Everyone is talking about the debt ceiling, and what could happen if the U.S. begins defaulting on its debt. Right now, the government isn’t supposed to get into debt further — the amount that the U.S. can borrow, by law, has been reached. Of course, in order to meet obligations, the government needs to borrow more in order to make interest payments on what it already owes. Treasury Secretary Timothy Geithner has identified August 2, 2011 as the date at which the money shuffling he has implemented stops being effective. At that point, the U.S. might begin to default on its debt.

But, what does it matter to most ordinary people? Are you really going to be affected if the government can’t borrow more money, and if Moody’s cuts the U.S. credit rating from its sterling AAA rating? (S&P is threatening to cut the rating straight to a D if the debt ceiling isn’t raised in time.) Laying aside the potential halt to government projects that you might have an interest in seeing completed, there might be some more immediate impacts of a U.S. debt default.

Possible Impacts of a U.S. Default on Your Finances

Of course, nobody can say, for sure, what would happen in the event of a default. After all, the financial markets run largely on perception. We can’t know what will happen until we actually reach that point. Many experts agree that a U.S. debt default would likely result in an economic slowdown, damaging a recovery that is already quite fragile. Plus, there will be a number of people in the cold, since a default would trigger a rather harsh system of deciding who gets paid first, and that could affect some individuals in terms of government programs, employees, and even Social Security payments to those on fixed incomes.

Other impacts could come due to another stock market crash in the financial markets. Once a default takes place, U.S. debt immediately becomes more expensive to finance. Treasury bond rates would likely skyrocket, and the mortgage rates that are influenced by long-term Treasury rates could also rise. Other interest rates might be affected as well, as dollar-denominated debt in general becomes more expensive.

A credit market crunch — worse than what we saw after the 2008 financial crisis — is likely to be a reality in the event of a U.S. debt default. This means that your ability to get a loan for a car or a home, and even for an education, will be compromised, and small business will have a hard time getting the loans they need. And, with small to medium sized businesses struggling with cash flow issues, another round of lay offs could be seen. You may have survived the last round of job losses, but could you survive another?

Another possibility is that you could see your retirement account take another hit. Many people’s investment portfolios have begun recovering from the last crisis. However, all that work would be undone if a default threw the stock market into a huge plunge. (On the flip side, those of us still quite a ways from retirement might just go on a bargain buying binge.) And, of course, no matter how you slice it, higher taxes are probably coming.

We like to think that the troubles of politicians wrestling with questions like this are so far removed from us. However, you are likely, in your personal finances, to be affected if the U.S. defaults on its debt. Are you ready?

4 Responses to U.S. Debt Default: How Would It Affect You?

  1. I guess you can only begin to prepare as much as possible and see what happens. Living within one’s means is vital. I also have put options on every stock I own which would help take some of the bite out of a market decline.

    • Arohan says:

      The markets will be volatile if this happens but there is no way of saying that the stocks will go down on a sustained basis. All the cash that flows out from treasuries will need to find some place to park and I am sure that the FDIC guarantee on the bank accounts will not hold much water. A lot of people will come to realize that many of the corporations are very strong financially and can offer higher returns for, get this, lower risk :-)

      Frankly, what we might be looking at is an inflation spiral as the USD keeps getting devalued and more money will need to be printed. Best place to be in such a situation is hard assets (cash is the worst). Silver lining is that this might actually help real estate grow in value and thus fix a lot of underwater mortgages.

      But ultimately, who knows.

  2. kosh says:

    China owns most US debt.

    You think your local debt collector is bad. You wait until the Chinese government comes knocking.

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