Q. Isn’t the fight over the debt limit about an out-of-control budget deficit? Doesn’t government spending need to be cut?
A. This year’s deficit will likely be the smallest in five years, thanks to higher tax revenue and government spending cuts. The CBO projects that the deficit will be $642 billion for the budget year that ended Sept. 30. Though still large by historical standards, that compares with the four previous years of $1 trillion deficits. Many economists think it’s healthier for spending cuts to be made gradually — rather than from a huge and immediate cut of the kind that would follow a breached debt limit.
Q. Why is it potentially catastrophic for the government to miss a payment on its debt and default?
A. In part because the repercussions would be felt worldwide by a global economy that still isn’t at full health. Banks in the United States and overseas use Treasurys as collateral when they borrow from each other. If Treasurys were no longer seen as risk-free, it would disrupt borrowing and jolt credit markets. A financial crisis like the one in 2008 could follow.
Banks also hold much of their capital reserves in Treasurys. If they fell in value after a default, banks would have to cut back on lending.
“A default is an unacceptable event,” says Judd Gregg, CEO of SIFMA, a Wall Street lobbying group, and a former Republican senator. “It will have an incredibly negative effect on the markets and ...everyday Americans.”