What to do If We Default
Tuesday, July 26, 2011
Welcome to Politics Bites, where every afternoon at It's A Free Country, we bring you the unmissable quotes from the morning's political conversations on WNYC. Today on the Brian Lehrer Show, Beth Kobliner, financial journalist, author of Get a Financial Life: Personal Finance in Your Twenties and Thirties, and member of the President’s Advisory Council on Financial Capability, gives advice on how to plan for the possibility of the U.S. defaulting on its debts.
The impasse in Washington DC stretches on. With one week to go on the debt ceiling debate before the United States defaults on its obligations, the federal government, state treasuries and other countries are coming up with contingency plans in case no agreement is reached.
Beth Kobliner gives news you can use on what happens if the U.S. defaults on its debts.
Keep Calm and Carry On
Kobliner said it’s too soon to panic.
This is one of those times that stay the course, hold tight, all those theories make a lot of sense… You can’t time the market, you can’t figure out what’s going to happen next, so there’s no bets to be made for the individual investor.
She said now is a good time to reexamine your portfolio and make sure it is diversified, with a good balance of stocks and bonds and money funds.
But Simon Johnson Says We’re Heading For Calamity!
Simon Johnson, the former chief economist at the IMF wrote a recent article for Slate saying that a default would “destroy the credit system as we know it,” with a depression-style run on cash.
Kobliner said that does not mean it’s time to hide your cash under the mattress.
If you have money in a bank, you know you’re getting pitiful interest rates, you’re getting less than one percent, but your money is safe there, you know its protected under $250,000 by Federal Deposit Insurance.
Even if the US does default, Kobliner pointed out that it is a technical default only – it doesn’t mean that the country will never be able to pay its bills.
What About Interest Rates?
Even if the US does not default, interest rates may increase. That’s because the uncertainty caused by the current deadlock may cause a credit downgrade, sending the US from a AAA rating to a AA or even a temporary D.
This could mean an increase in mortgage rates, as well as interest rates on private student loans, also car and business loans.
What we’re seeing is, if the US is having trouble trying to figure out how to figure out its long-term economic outlook and bring down the debt and take care of it, that is something that the rating agencies are looking into.
Long-Term Treasury Bonds
The type of debt most imperiled by a default is long-term debt.
When a downgrade occurs, that means that the bonds are less attractive now, so they have to pay a higher interest rate to attract investors, so that means that when interest rates go up on bonds, prices go down. So that means the price of your bond is worth less.
The answer? Kobliner said to make sure your portfolio is diversified with a mix of long-term, short-term and medium term debt.
The debt ceiling has been passed 74 times since its invention after World War I, and ten times in the last ten years. So why the big fuss this time?
Kobliner said the Tea Party has forced the Republican’s hands on the matter, with many in the Tea Party actually in favor of a default, on the theory that a default will force the government to borrow less.
It’s basically a crazy argument, from people who don’t really understand the economy, and I think that it’s a dangerous game they’re playing, and pushing it to the last minute like this, is, I think, unfair to the American public and for Main Street.
While Wall Street may be giving this a yawn, Kobliner says these antics are causing great stress among regular people.
Go For the Gold?
Gold is at $1,600 an ounce, the highest it has ever been. While many rumors (and advertisements, and Glenn Beck) might have you thinking a purchase of gold is a smart investment in these uncertain times, Kobliner says it’s really not that great of a plan.
The problem is that’s been built into the market already…it’s too late already. Anything you’re thinking about—I’m sorry to say—that, ooh, this is a clever idea, Wall Street has already done, and it’s built into the price.
Is There A Silver Lining?
Maybe. If the US does get downgraded and interest rates rise, it could actually benefit senior citizens on fixed incomes, who might see rising returns on their money market funds.