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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.

Why Now?

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.

 

Guests:

Alec Hamilton

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Comments [18]

It's A Free Country Producer

As always, we welcome your comments and ask that you keep them civil and on-topic.

Jul. 26 2011 01:14 PM
Lenore from Manhattan

Mr. Bad should be excluded from this list for his insults. If I wanted that stuff I could read many other comment lists.

Jul. 26 2011 11:00 AM
jgarbuz from Queens

Can't kick the problem down the road again, because there is no more road. The gov't has no money to build more roads. We've pretty much hit the wall.

Jul. 26 2011 10:33 AM
jgarbuz from Queens

A country goes into debt when it consumes more than it produces. Aging population consumes more resources than it produces. Our military does not loot enemy countries; it builds them up. In ancient times, if you defeated your enemy, you took everything, including slaves, and resources, and/or collected taxes and tribute.
We defeat enemies, and then pay to build them up again.

We are we so heavily in debt? Let me count the ways :)

Jul. 26 2011 10:27 AM
Brenda from Brookyln

You know what's dangerous. Kicking this problem further down the road. If now is not the time to get this problem under control, I don't understand what it. This is only showing there is too much reliance on much of the population on the government. If we push this problem further down the road we risk complete economic collapse, so please I am tired of talking points that push for a blind increase in the debt ceiling. While it is true that we can just riase it, it is a rediculous situation, can you blindly raise your credit limit on your visa? please.

Jul. 26 2011 10:26 AM
John H from New York

Your guest seems to be saying exactly what she would say if there were no risk of default or downgrade. Diversify, mutual funds, etc. How can it be that this dramatic moment has no ramifications for investors?

Jul. 26 2011 10:26 AM
Larry from Brooklyn

My understanding is that "default" occurs only if we stop making payments on loans. If no debt limit increase occurs, we could still pay loans but we would then only rely on tax revenue which pays for only 60% of expenses. There would be a 40% cut in federal spending... this needs to be discussed more than a true default which no one thinks will happen.

Jul. 26 2011 10:25 AM
Chriss from Montclair

Beth is a bit too dismissive of the Tea Party.

And while I am not one of them, I am always wary of folks to dismiss them with a "they don't know what they're talking about" as Beth did.

Is running up more debt and spending more the preferable position?

Jul. 26 2011 10:25 AM
josh Karan from Washington Heights, NY

While I understand the importance of this discussion to those who have money, for those who don't isn't the so-called "compromise plan" with all its cuts to social programs worse than the consequences of a technical default?

Jul. 26 2011 10:23 AM
John from NYC

I still not have no answer to the question I posted twice before:

Why does the US have any debt or deficit at all?

You go into debt for a big ticket item that will increase your income/wealth in the future--like an InterState Highway system.

We have not built anything like that in the past 40 years.

The only other reason to go into debt is for Congress to pay off voters for their re-election -- is that the definition of a Banana Republic or what?

Jul. 26 2011 10:22 AM
jgarbuz from Queens

Farewell, America! The Dream was nice, while it lasted.

Jul. 26 2011 10:21 AM
ericf

As regulated entities the ratings agencies are not neutral observers and IMHO not credible at all in this context, but I have no idea what's to be done about that.

Jul. 26 2011 10:21 AM
Mr. Bad from IL

Chances are good that this propagandist will spew a lot of nonsense so it's probably best to defer to one of the few sensible and intelligent observers of the current situation, Marc Faber.

Faber's argument is vis a vi the only other respectable financial perspective: endless deflation essentially.

He observes that the "deflationist" camp hate every asset class, for good reason, because the US is a ponzi scheme and blah blah blah so buy bonds because they're guarnteed but as Faber correctly observes in the event of terminal deflation tax revenues would fall drastically and the US would default in the old fashioned way, we simply couldn't pay the interest and so US treasuries would be worthless anyway.

The other type of default, the more likely IMO and Faber's is more "quantitative easing", i.e. money printing. We will inflate away our debt by depreciating the dollar. In that case Faber says buy gold, farmland and equities. Even by Faber's own definition of money, gold is not money, it is a store of value but it cannot be converted to good and services without barter or conversion to cash so I stay away, it is also the best performing asset of the last ten years, which is scary in and of itself.

Best thing to do, buy equities (stocks) which will rise with inflation and focus on energy and emerging markets ETF's. Have a small amount of foreign currency for insurance against a possible "structural collapse" of the Bretton Woods system, CADN or Swiss Franc would do best. Stay away form bonds, especially US treasuries, the real interest rate is NEGATIVE and will get worse, not better. The rate of return is negative because the interest rate is lower than real inflation as measured by the Dept. of labor stats.

Jul. 26 2011 10:21 AM
Jim

If our debt is downgraded, and interest rates go up, will the Federal Reserve still find a way to keep savers from earning interest?

Jul. 26 2011 10:16 AM
Emily from Brooklyn

What about converting your American dollars into a stable foreign currency, such as British pounds?

Jul. 26 2011 10:15 AM

I just changed jobs and don't have a 401(k) any more. Should I leave my money in the old account for now until things calm down? Or is it ok to switch it to a Rollover IRA now?

Mary

Jul. 26 2011 10:12 AM
pordy from Madison, NJ

Annoyed that phone and email is not working for my representative (Frelinghuysen, Morris Co, NJ). Good god, people, stop playing political chicken with the world economy.

Jul. 26 2011 10:11 AM
Tony from Santa Clara, CA

How do you buy German Treasury bonds (Bunds)?

Jul. 26 2011 10:09 AM

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