Treasury Warns Default Could Result In Recession Worse Than 2008 Financial Crisis

The Treasury Department warned Thursday that a default by the U.S. on its debt caused by political brinksmanship could have “catastrophic” consequences that might last decades.

“Credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse,” the Treasury said in a brief report intended for members of Congress and also released publicly by the agency.

A stalemate on fiscal issues between the Obama administration and Republicans in Congress has led to a partial government shutdown and concerns that the $16.7 trillion debt limit won’t be raised in time to ensure the Treasury has enough money to pay the nation's bills.

While the shutdown will probably take a small bite out of economic growth, a failure to raise the debt ceiling would not just involve the furloughing of nonessential federal employees. It could also mean that Social Security payments are missed, that government contractors aren't paid, and that holders of Treasury notes and bonds won't receive their coupon payments. The Treasury expects to be down to its last $30 billion by Oct. 17.

A similar standoff in the summer of 2011 prompted ratings agency Standard & Poor’s to cut the U.S. credit rating, an unprecedented event that roiled markets. The S&P 500 (INDEXSP: .INX) fell about 17 percent in the period surrounding the 2011 debt limit debate and did not recover to its average over the first half of the year until into 2012.

Roughly half of U.S. households own stocks either directly or indirectly through mutual funds or 401(k) accounts, so this fall in equity prices reduced household wealth across a wide swath of the economy. Between the second and third quarter of 2011, household wealth fell $2.4 trillion. A decline in household wealth tends to lead to a drop in consumption spending, and consumer spending accounts for roughly 70 percent of gross domestic product.

“As we saw two years ago, prolonged uncertainty over whether our nation will pay its bills in full and on time hurts our economy," Treasury Secretary Jacob J. Lew said. “Postponing a debt ceiling increase to the very last minute is exactly what our economy does not need -- a self-inflicted wound harming families and businesses. Our nation has worked hard to recover from the 2008 financial crisis, and Congress must act now to lift the debt ceiling before that recovery is put in jeopardy."

Banking analyst Richard Bove also warned Thursday that a default by the U.S. government would plunge the world into a depression so severe it would take decades to recover.