Summers: Default unthinkable

Ex-Treasury secretary says it would cause more panic than Lehman Brothers

WASHINGTON: A US debt default would cause panic throughout the financial system and long-term uncertainty, former Treasury Secretary Larry Summers told CNN.

“It seems to me an unthinkable financial risk to take,” Summers said in an interview on yesterday's “Fareed Zakaria GPS” programme. It would cause “a cascade that makes Lehman Brothers look like a very small event.”

The bankruptcy of Lehman Brothers Holdings Inc in September 2008 was the biggest in US history and was followed by a collapse of credit markets and a 43% decline in the S&P 500.

In 15 days, the US will begin to default on its debt obligations unless Congress and President Barack Obama can agree on a deal to raise the debt ceiling. Obama has been trying to break an impasse over whether to include cuts in entitlement programmes and tax increases in the deal.
‘The ability to carry on routine financial business would be lost.’ – Reuters

Summers said a potential default made him worry about “runs on banks, runs on money market funds,” exchanges facing “the prospect of collapse, institutions that had been built over decades” being “swept away.”

“The ability to carry on routine financial business to clear checks, to pay bills, to meet obligations would be lost,” he said.

“It would be a totally self-inflicted cataclysm,” he said.

“There's no question the United States can meet its obligations. This idea that somehow that we cannot pay because we're having a political fight over how to handle the spending and taxing” is “democracy functioning in the worst possible way,” he said.

Meanwhile, AFP quoted analysts and officials as saying that the US economy would face a shock worse than the 2008-2009 financial crisis if the government failed to raise its borrowing cap before Aug 2.

While attention has focused on the possibility of an unprecedented US default on its debt, economists say the government is more likely to slash spending come Aug 2, the day spending needs surpass receipts.

And at the current size of the budget deficit, that could mean cutting 40% shutting down much of the government, halting paychecks to soldiers, closing courts, or delaying social security payments to seniors.

“That would be really catastrophic,” said Michael Ettlinger of the Center for American Progress.

Ettlinger said if the debt ceiling remained frozen through September, it would force a quarterly economic contraction over more than 2% worse than the worst quarter in the 2007-2009 US recession. In that quarter alone, two million jobs were lost.

Whether the government chopped spending or reneges on debt payments, it would be a disaster, he said.

Washington already reached its US$14.3 trillion borrowing ceiling on May 16, as the stubborn political impasse over a long-term deficit plan has prevented raising it.

Through a mix of operational changes at the Treasury, the government bought some time. But in less than three weeks, something has to give: commitments will outpace receipts, and no new borrowing will be allowed to cover the gap.

“The Treasury has no secret bag of tricks to finance government operations past Aug 2,” the independent Bipartisan Policy Center said in a report this week.

The centre said the Treasury would have to stop 40%-45%, or US$134bil worth, of the 80 million monthly bills it paid.

If it sticks with servicing its debt, paying social security and health benefits, military contractors and unemployment insurance, it would still have to shut down the Justice and Labor departments, road-building, veterans affairs, health research, small business support, and a slew of other operations.

Such cuts, Federal Reserve chairman Ben Bernanke told members of Congress last week, would be like the Great Recession all over again, with massive layoffs even while 14.1 million Americans are already unemployed. Agencies