Until recently, asking what would happen if the U.S. defaulted on its debt was like asking what unicorns like to eat for breakfast. It was simply an exercise in absurdity – a question whose answers lay outside the realm of possibility. But as it’s become increasingly clear that we could, in fact, default on our debt later this month, if the current attempts at striking a deal to extend the debt ceiling fall apart or simply take too long, it's worth trying to figure out what exactly would happen in a default scenario.
In recent days, I’ve spoken to a number of financiers and policy experts on what could happen if we reach the “X Date” – the date on which the United States Treasury has burned through all of its cash, and is no longer able to cover its expenses. (The Bipartisan Policy Center expects this date to come between October 18 and November 1, but for simplicity's sake, let's assume it happens on an appropriately scary date – October 31, Halloween, and the day a huge interest payment on U.S. debt is due.)
I asked these experts to indulge me in a speculative exercise, and give me a medium-case scenario of what could happen on the X Date – not the worst-case scenario, not the best-case scenario, just a reasonably pessimistic imagining of how that day might go, from morning until night. Here's what they told me might happen:
12:00 a.m. – Staffers at the Treasury Department and the Federal Reserve will be up all night, testing vital systems before today's market opens. Several hours earlier, Treasury Secretary Jack Lew gave his staff notice that the U.S. would no longer be able to prioritize its payments – paying certain bills before others – and would have to miss a scheduled interest payment on its debt, triggering a technical default.
These technicians have spent the last few weeks building and testing software patches they believe will keep vital systems like Fedwire – the Federal Reserve's payment clearing system – running as usual even in the event of a default. But they can't know for sure that the patches will work. One of their biggest worries is about the repo market – the daily exchange of Treasury bonds and other securities that allows banks and other institutions to secure short-term funding. Some dealers are already refusing to accept certain Treasury bonds as collateral on repo transactions, and even though they've been reassured that Fedwire and other systems will allow defaulted Treasury bonds to flow through their plumbing normally, there's still the risk of a mistake.
7:00 a.m. – Wall Street traders arrive at work for the day. They’re all anxious, but their exact moods depend on their specific area of the market. Stock and bond traders are terrified about what will happen to their portfolios for the day, whereas commodities and volatility traders know they’ll have some good opportunities to profit from today's madness. In every trading firm across the country, the coffee is made extra strong.
8:00 a.m. – House Speaker John Boehner wakes up in his bed, after a short and sleepless night. He spent most of the past 24 hours begging House Republican holdouts to come to their senses and extend the debt limit with a deal hammered out by Senators Harry Reid and Mitch McConnell hours earlier. By all indications, he'll lose his job if he brings the compromise bill for a vote against the wishes of dozens of members of his caucus. But he's still waiting for the bill: Sen. Ted Cruz has decided to extend negotiations in the Senate through a technicality that allows him to force 30 hours of post-cloture debate, effectively filibustering a deal until after X Day. (The senator insists that the risks of default are wildly overstated, as do some members of Boehner's caucus.) The speaker checks his phone and sees a flood of panicked, all-caps e-mails from constituents, donors, and colleagues asking whether he's been able to get a deal done.
9:00 a.m. – President Obama holds a press conference, flanked by his economic advisers. With slight tremors in his voice, he points to the sharp declines in pre-market trading as proof that without a deal, "our nation's economy could be irreparably harmed." He says that he has been informed by Secretary Lew that today will be the day that the United States of America fails to make a timely payment on its debt.
9:30 a.m. – Stock markets open. The Dow and S&P 500 both open down – about 3 percent apiece – but they haven't fallen off a cliff yet. The market, it seems, is still bracing for an eleventh-hour deal. And even though the U.S. has technically defaulted on some of its debt, the bond markets remain relatively calm. Oddly, yields on Treasury bonds – the same kind that just defaulted – are steady, since investors are running to safe assets amid the stock market's volatility. But the CBOE Volatility Index, or VIX, the so-called "fear gauge" that tracks expectations of big market moves, is moving up to its highest point of the year. And gold and other hard-metal prices are rising steadily, as investors fear for the future of the dollar.
10:30 a.m. – More press conferences. Sen. Cruz appears, flanked by tea party congressmen, to blame the default on President Obama's unwillingness to come to the bargaining table. The National Committee to Preserve Social Security and Medicare urges Congress to act before senior citizens miss their Social Security payments, and calls Republican intransigence "a threat to the lives of millions." A conference organized by The Campaign to Fix the Debt asks Congress to put together a solution to the nation's long-term debt crisis, in addition to extending the debt limit.
11:30 a.m. – CNBC reports that Fedwire – the New York Fed's clearing system that processes billions of dollars in payments every day – has seized up due to an "unforeseen technical glitch" having to do with the defaulted Treasury bills. The Fed's plans to allow markets to cope with defaulted Treasury bonds haven't worked as planned, and several large banks have stopped accepting all Treasury bonds as collateral for short-term repo financing contracts, the network reports. Stocks plummet. The Dow is now down more than 5 percent, and the S&P 500 is down 6 percent.
Noon – The S&P 500 keeps falling, which triggers the first of the New York Stock Exchange’s trading curbs and shuts down all stock trading on the New York Stock Exchange temporarily. These “circuit breakers,” as they're called, are meant to keep markets from panicking, and in this case, the loss of Fedwire and the failure of the Federal Reserve's backup systems means that it might be stopping a Black Monday-esque panic. Around Wall Street, long-only equity traders are yelling and throwing phones, but others – the ones who held out short positions, or traded with the expectation of high volatility – are cheering. They're on track for record profits today. Assuming the markets open back up, that is.
2:00 p.m – Stock markets have re-opened, but are still falling. World leaders are begging the U.S. not to risk the health of the global financial system over a domestic political dispute. A CNN reporter tracks down tea party Congressman Ted Yoho in the hallways outside his office, who dodges the reporter's questions about his previous statement that a U.S. default would "bring stability to the world markets."
3:00 p.m. – Politico reports that Secretary Jack Lew has entered a closed-door meeting of House Republicans, and is imploring them to pass a bill extending the debt limit. "Stop the carnage," Lew is heard to say, by a reporter in the hallway outside.
3:30 p.m. – Bloomberg reports that several of the largest U.S. asset managers, including BlackRock and Fidelity, are reassuring investors that they have kept all short-term Treasury bills out of their money funds, and that they are looking at ridding themselves of longer-dates Treasuries as well.
4:30 p.m. – Markets close. The Dow finishes down 600 points, or about 4 percent, and the S&P finishes the day down 5 percent. Gold is up about the same amount, while Treasury yields have shot up, with 10-year yields topping 3 percent. CNBC's Jim Cramer calls this "the wildest rodeo we've seen since Lehman."
6:00 p.m. – As evening news programs show footage of Americans lining up at ATMs to retrieve cash from their accounts.
7:00 p.m. – The day's events have scared Congress into action. Cruz's delay is finally over, and the Senate bill — which pushes the debt ceiling to February 15 — reaches the House. Over objections from conservative holdouts, Speaker Boehner immediately puts it up for a vote. It passes easily, with many Republicans having been spooked into submission by the market turmoil of the day. In a hastily assembled press conference, President Obama signs it.
8:00 p.m. – Stock market futures are rallying on news of the deal that will ensure that bondholders get paid. But the worst is far from over. Foreign investors have already lost confidence in U.S. fiscal stability, and many large asset managers remain concerned about holding Treasury bonds. In addition, the software patches applied to Fedwire and other processing systems to make them default-compatible now need to be reversed. And in February, the whole process starts anew. Already, Ted Cruz has appeared on Fox News, where he promised to make next year's debt fight "even bigger" than this one. "I will not rest until Obamacare, the scourge of our nation, is dead and beyond resuscitation," Cruz says.
10:00 p.m. – The Asian markets show a slight recovery ahead for tomorrow's trading day. But the economy is by no means back to normal, despite a short-term deal that will allow Treasury to pay its bills for a few more months. Investors are openly questioning whether the U.S. Treasury bond can ever be considered a risk-free investment again. And major ratings agencies, such as S&P and Moody's, are gathering tomorrow to put the final touches on announcements stating that they're downgrading the U.S.'s credit rating. Across the country, bank executives and lenders are preparing to raise interest rates on mortgages and personal loans, and 401(k)s are still reeling from the market turbulence. On Wall Street, short-sellers and volatility traders are smiling, having made out well on the day. But in Washington, the air is still filled with tension – and will be, for at least the next four months.
Note: Even if little or none of the above actually happens, we're still not in the clear. As Felix Salmon points out, much of the damage of a default has already been done, even if we head off technical default with a last-minute deal.