With the budget stalemate playing out in Washington in recent weeks, talk of the default on federal debt has been in the news. What does a debt default mean, and what would be the consequences? N.C. State University economist Mike Walden explains.
“Well, let me try to personalize this. Most people have debt. Many people have, for example, mortgage debt. And that requires that households make a payment to the holder of their mortgage. That covers a little bit of the principal, as well as the interest. And if that person does not make those payments consistently, the lender can come in and start legal procedures to actually take over the house. That would be a default on the debt from that homeowner for their home.
“Well, we have a similar situation with our federal government. The federal government owes a lot of money, about $17 trillion, and there is the possibility that if budget situations in Washington are not resolved, the federal government would not be able to make the interest payments on that debt.
“Now, before some people say, “Well, those interest payments go to foreign countries. We really don’t care about them,” actually about half of those interest payments come to domestic holders of debt. Many people may not know it, but through their mutual funds, they probably own some federal debt.
“Secondly, there would be the concern that if the federal government were not to make interest payments on their debt, that would affect the interest rate that they would have to pay in the future on new debt. The problem there is it would not just affect federal interest payments and interest rates; it would affect all other interest rates in the economy, because the interest rate on federal debt sort of sets a floor for all other interest rates. So all other interest rates would likely ratchet upward. So it’s probably not a good situation to be in to default on debt.
“Again, regardless of what people think about how we got there, it’s probably not a good thing to say, ‘We could default on our national debt.’”