If the US defaults on its debt, here's how it will affect your savings, cash investments and 401(k) (2023)

Table of Contents
Bank deposits money market funds

The debt ceiling standstill puts the US government's liquidity management problems in the spotlight.

It is less than a month from the earliest date, says Treasury Secretary Janet Yellen, that the federal governmentyou may not be able to pay all your bills, and meet all your debt obligations. Others, including party political onesCongressional Budget Office,they estimate that the government may exhaust its ability to pay all its bills by early June.

President Joe Biden and House Speaker Kevin McCarthywe met on Tuesdayto negotiate a deal that raises the debt limit to $31.3 trillion and preserves the country's full confidence and credit. McCarthy later told reporters that "I saw no new movement.Another meeting is scheduled for next week aftera Friday meeting was postponed.

observersthey didn't expect a dealTuesday. But theyexpecting an agreementto avoid default by the United States.

If the government exhausts its ability to pay all its bills, cash-management problems could spread beyond the federal government and drag down economies, investors and households, experts say.

Even a remote possibility of default is worrisome. After the "X date," when the government exhausts its ability to pay all its bills, cash management problems could spread far beyond the federal government and drag down economies, investors and households, experts say.

Bank deposits will still be covered up to $250,000 due to Federal Deposit Insurance Corporation protection. But the loan interest rates can rise further, they say.

Even without the drama of the debt ceiling, interest rates have already been rising andthe banks have already tightened credit standards.

Meanwhile, money market funds with exposure to sovereign debt could prompt many institutional and retail investors to ask for their money back, experts said.

Money market funds with exposure to sovereign debt could prompt many institutional and retail investors to ask for their money back, experts said. Banks are already tightening credit standards.

Rising interest rates and volatility in the banking sector have drawn more money into conservative and highly liquid mutual funds, which currently hold more than $5.7 trillion in cash.

"This is the worst possible time to have a deadlock," said Urooj Khan, a professor at the University of Texas McCombs School of Business where he studies financial crises.

Of course, there is never a good time for the federal government to default. "It is widely accepted that financial and economic chaos would ensue," Treasury Secretary Janet Yellen said in a statement.ABC interview Sunday.The "X date" could come as early as June 1, Yellen said.

Of course, cash is only one part of a portfolio for building and preserving wealth. At the Bipartisan Policy Center, the potential for a stock market selloff that would destroy retirement accounts worries some observers more than the implications of a potential default for cash investments.

A prolonged default would wipe out 45% of the value of the stock market,according toWhite House Council of Economic Advisers.

And if that happened? "Your 401(K) is now a 201(K)," said Jason Fichtner, vice president and chief economist at the Bipartisan Policy Center, a Washington, D.C.-based think tank. that promotes bipartisanship.

At a time when people have been paying more attention to savings returns, and thesecurity for your deposits— Here's a look at the consequences of a breakup:

Bank deposits

Any default still doesn't change the fact that the Federal Deposit Insurance Corporation guarantees deposits up to $250,000 per month. deposit per account, Khan said.

Indeed, an FDIC spokesman said that "people's money in deposit accounts is still available to them on demand" and certificates of deposit "still accrue interest. The deposit insurance coverage remains the same."

When the Federal Reserve raised benchmark interest rates to cope with inflation, interest rates on bank accounts rose with them. What couldeven be the highlightto capitalize on the returns on savings accounts and CDs, experts said.

But immediately after any default, banks may come under pressure and need deposits to maintain liquidity, Fichtner said.

Consumer-oriented credit, such as mortgages and auto loans, tends to track Treasury yields. Price and yield move in opposite directions, and a debt default can send interest rates skyrocketing.

Banks would have "every incentive" to hold deposit accounts, so in the immediate aftermath they would likely keep their deposit rates competitive, he said. "We've never done this before. I hope we don't find out," Fichtner added.

But if banks were under pressure to keep deposit rates competitive, Fichtner and Khan said, lending rates for all types of credit to households and businesses would skyrocket.

Consumer credit, such asmortgage loanand auto loans, tend to follow Treasury yields. Price and performance are moving in opposite directions. So if the market price of government debt falls because it is no longer considered a safe haven for investors, that jump in yields would have big consequences.

"Everything is comparable to them," Khan said of national debt. So if Treasury yields rise because of increased risk, credit for "all other assets will also reflect that risk."

The White House agreesthis latest blog: “The ability of households and businesses, especially small businesses, to borrow through the private sector to offset this financial pain would also be compromised. The risks generated by default would send interest rates skyrocketing, including interest rates on financial instruments used by households and businesses: government bonds, mortgages and credit card interest.

Interest on mortgages, now exceeding 6%, could rise to 8.4% in the event of default,according to forecasts Thursdayde ZillowZ, -0,02 %.Rising default rates would make monthly mortgage payments 22% more expensive for September, the property company said.

Fil: This is where investors can "hide" as the US debt ceiling deadline approaches based on the market reaction in 2011

Even negotiations can get rates up. Mortgage rates rose by about 0.7 to 0.8 percentage points over two months during the 2011 debt ceiling negotiations and fell slowly after the deal, according toWhite House Council of Economic Advisers for the Biden Administration.

Now, short-term Treasury yields are already showing jitters as spooked investors eye debt maturing around date X.

The yield on a three-month Treasury billTMUBMUSD03M, 5,342 %recently rose to a level not seen since January 2001. One-month T-bill yieldsTMUBMUSD01M, 5.670%float at levels dating back to 2008.

Increased performance in the short termcould be a possibilityat a time when Treasuries were already an attractive place for cash, according to Bill Gross, former co-founder of Pimco, an investment management firm that focuses on active fixed income management.

money market funds

Money market funds consist of holdings such as high quality, fast maturing government debt. Although considered extremely low risk, deposits in these mutual funds arenot subject to FDIC coverage.

Ten consecutive rate hikes by the Federal Reserve have turned money market funds intoa more tempting destination for return.Banking system concernspushed even more moneyfunds from deposits in the banking system.

Money market funds were at a record $5.73 trillion this week, according to Peter Crane, president of Crane Data, which tracks the money market industry. Fund amounts have set and reset size records for two months, he said. Investors poured $300 billion into them in the three weeks to March 29.

Of the $5.7 trillion, more than $3.75 trillion is money from institutional investors, and another $1.86 trillion comes from retail investors, according to Crane Data.

Different types of money market funds have different degrees of exposure to a default crisis, Crane and others explained. There are government money market funds, some of which are the Treasury's money market funds. "Major" money market funds can invest in government debt and securities, but also in low-risk commercial holdings. Municipal money market funds (debt securities issued by state or local governments) are another option.

As interest rates continue to rise, Crane said the funds' main investment is repurchase agreements. Those deals, super-short-term loans backed by collateral like Treasuries, make up more than $3 trillion, more than 57%, of the funds' holdings, according to Crane.

Treasury debt is a distant second, accounting for $1 trillion, or 18%, of funds, Crane said.

So what happens to shares of a money market fund in the off chance of default?

One threat would be to "break the money," said Khan, of the University of Texas.

Money market funds seek to keep their net asset value at a stable value of $1 per share. stock and breaking money when the stock price is below $1.

The implication of breaking the money is that you invested $100 and now you're going to get $98," Khan said. "Breaking the money basically means that the investor doesn't get 100% of their investment back at that point ."

"Safety and liquidity have always been, and will continue to be, our top priority goals in managing money market funds for our clients, regardless of market conditions."

— A spokesman for Fidelity

That happened16. september 2008, a day after Lehman Brothers filed for bankruptcy, when investorsaccelerated money market fundsto get your money back. The Federal Reserve and the Treasury Department had to quickly support money market funds after Lehman's collapse.

What would happen if the investors pulled out a lot of money en masse? Crane said much of that would likely exceed the FDIC's deposit guarantee. "There's nowhere to run," he said. "Everything is a lot of money. They are all uninsured deposits.”

Still, the prospect of breaking the bank on a large number of trade requests would be "outlandish," according to Crane. On the one hand, there has beenchanges to the rules for such refunds, he noticed.

The funds can shift their Treasury holdings to minimize maturities around the X date, Crane, Khan and others noted.

Large money market managers such as JPMorgan Chase & Co.JPMand Vanguard, did not respond to a request for comment.

"Safety and liquidity have always been, and will continue to be, our top priority goals in managing money market funds for our clients regardless of market conditions," according to a spokesperson for Fidelity, another major money market fund manager.

"Our money market funds are conservatively positioned in light of debt ceiling risks, and our funds invest in high quality money market securities and maintain high levels of liquidity," the spokesperson told MarketWatch.

Read more:

Do you think 6% mortgage rates are too high? That's how bad it can get if the US defaults on its debt.

Top Articles
Latest Posts
Article information

Author: Aron Pacocha

Last Updated: 05/13/2023

Views: 6225

Rating: 4.8 / 5 (68 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Aron Pacocha

Birthday: 1999-08-12

Address: 3808 Moen Corner, Gorczanyport, FL 67364-2074

Phone: +393457723392

Job: Retail Consultant

Hobby: Jewelry making, Cooking, Gaming, Reading, Juggling, Cabaret, Origami

Introduction: My name is Aron Pacocha, I am a happy, tasty, innocent, proud, talented, courageous, magnificent person who loves writing and wants to share my knowledge and understanding with you.