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U.S. Reaches Debt Limit, Geithner Warns Of Dire Consequences

Debt Limit Geithner Default

First Posted: 05/16/11 11:21 AM ET Updated: 07/16/11 06:12 AM ET

The federal government reached its debt limit Monday, and Treasury Secretary Tim Geithner again detailed the disastrous and widespread consequences of Congressional inaction.

Skeptics continue to suggest that a failure to raise the debt ceiling would not significantly harm the economy, but Geithner argued the exact opposite, insisting that a default on the federal debt would deal a blow to the global economy, as a crucial pillar would be compromised. The federal government would be forced to freeze spending, including its payments to investors, businesses, citizens and the military, shocking the U.S. economy and potentially plunging it into a fresh recession, Geithner wrote in a Friday letter to Sen. Michael Bennet (D-Colo.). From the letter:

A default on Treasury debt could lead to concerns about the solvency of the investment funds and financial institutions that hold Treasury securities in their portfolios, which could cause a run on money market mutual funds and the broader financial system -- similar to what happened in the wake of the collapse of Lehman Brothers. As the recent financial crisis demonstrated, a severe and sudden blow to confidence in the financial markets can spark a panic that threatens the health of our entire global economy and the jobs of millions of Americans.

Abruptly freezing federal outlays, Geithner added, "would likely push us into a double dip recession."

The letter was the latest warning from a top economic official that delaying an increase of the debt ceiling could wound the economy for years to come. Federal Reserve Chairman Ben Bernanke, Council of Economic Advisors Chairman Austan Goolsbee and a host of independent economists have repeatedly stressed the importance of raising this limit, which currently prevents the government from carrying out the commitments that Congress has already made.

Now that the government has reached its debt limit, the Treasury is set to engage various temporary measures to tread water until August 2. At that point, it will have to default on some of its loans, Geithner wrote in a recent letter to Congress.

These "extraordinary measures," aimed at staving off default, began earlier this month, when the Treasury stopped issuing special securities that help state and local governments manage their debt. The next round of these measures -- in which the government liquidates certain investments of a pension fund and blocks other funds from new investment -- is set to commence Monday.

But lawmakers have downplayed the urgency of this issue. "When you say the drop-dead day is going to be August, I question that," Rep. Tom Rooney (R-Fla.) said, according to the Wall Street Journal last week.

Republican leaders in Congress have used the debt ceiling debate as a way to try to enforce fiscal austerity, saying they will not vote to raise it unless the legislation comes with measures aimed at reducing the deficit. Economists have criticized lawmakers for injecting party politics into the debate, and for essentially threatening to crash the economy in order to achieve this agenda.

But this Republican view has traction. Stanley Druckenmiller, the billionaire money manager who runs Duquesne Capital, said a default by the U.S. government would not cause lasting economic damage. The bigger issue is the federal deficit, he told the Wall Street Journal. As an investor in U.S. debt, he'd accept a late debt payment if it meant the government also made an effort to trim spending, he said.

"People aren't going to wonder whether 20 years ago we delayed an interest payment for six days," he said. "They're going to wonder whether we got our house in order."

Others in the financial community have disagreed, however. "We are particularly concerned by the growing belief that hitting the August drop-dead date would be no big deal," Bank of America chief economist Ethan Harris said in a note last week.

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