Delayed payments in 1979 offer glimpse of default consequences

The Washington Post

Brady Dennis 

Sunday, July 10

The Sunday airwaves brimmed once again with talk of what would – or would not – happen if lawmakers fail to meet the Aug. 2 deadline to raise the nation’s legal limit on borrowing. Unmentioned by either side was an obscure bit of budgetary history in which the country did default on some of its bills, and wound up paying the consequences.

Treasury Secretary Timothy F. Geithner said on CBS’s “Face the Nation” that inaction “would be catastrophic for the economy” and added that “no responsible leader would say the United States of America, for the first time in its history, should not pay its bills, meet its obligations.”

Bob Schieffer spoke with Treasury Secretary Timothy Geithner on the necessary steps to be made for the White House and congress to reach an agreement over a budget plan and ultimately raising the debt ceiling.

Across the dial on “Fox News Sunday,” Sen. Jim DeMint (R-SC) accused Geithner of “playing Chicken Little” and called his dire warnings irresponsible. “There certainly will be disruption, but this is not a deadline we should rush and make a bad deal,” DeMint said, echoing the views of some fellow conservatives who have downplayed the potential fallout.

In fact, there was one short-lived incident in the spring of 1979 that offers a glimpse of some of the problems and costs that might arise if the stalemate on Capitol Hill continues. Then, as now, Congress had been playing a game of chicken with the debt limit, raising it to $830 billion – compared with today’s $14.3 trillion – only after Treasury Secretary W. Michael Blumenthal warned that the country was hours away from the first default in its history.

That last-minute approval, combined with a flood of investor demand for Treasury bills and a series of technical glitches in processing the backlog of paperwork, resulted in thousands of late payments to holders of Treasury bills that were maturing that April and May.

“You hear lot of people say, ‘The government never defaulted.’ The truth is, yeah, they did . . . It might have been small, it might have been inadvertent, but it happened,” said Terry Zivney, a finance professor at Ball State University who co-authored a paper on the episode entitled “The Day the United States Defaulted on Treasury Bills.”

All things considered, the incident amounted to a minor blip. The Treasury had missed payments on about $120 million worth of bills, a tiny amount even then, given the global investment in U.S. debt. Investors, some of whom joined a class-action suit against the government to recover damages, eventually were paid in full with back interest. T-bills, as they are known, continued to be considered a safe investment. Treasury officials both then and now argued that the event was not even a default, but merely a delay caused by the internal logjam.

“It was quickly forgotten,” said Jim Angel, a finance professor at Georgetown University.

And yet, the study by Zivney and his partner, Dick Marcus, found that even that brief failure to meet some obligations had expensive consequences. The pair concluded “that the series of defaults resulted in a permanent increase in interest rates” of more than half a percent, which over time translated into billions of dollars in increased interest payments on the nation’s debt, a cost shouldered by taxpayers.

“The impact is smaller at first because only new debt is affected,” they wrote. “But over time, as the older debt matures and becomes refinanced at higher rates, the entire cost of the default is realized.”

Zivney said that the 1979 incident, which pales in comparison to the size and scope of payments the Treasury could have to forego if it can no longer borrow money come Aug. 2, offers a useful case study in the real-world consequences that result when the U.S. government doesn’t seem like the sure bet it has always been.

“It creates doubt, and I think that’s the real lesson,” he said. “The market has a much longer memory than individuals.”

Angel, the Georgetown professor, said that the surest way to stave off any such doubts is for Congress to find a way to set aside political fights long enough to ensure that the country continues to pay its bills. Otherwise, he said, investors will punish the United States – and ultimately taxpayers – if and when checks stop showing up.

“It’s not as if God appeared to Moses on Mount Sinai and said, ‘The U.S. will always be a AAA credit.’ Our reputation is something that we have earned,” Angel said, adding that history is filled “with countries that were once great and blew it. The simple lesson is, you’ve got to pay your bills on time. If you don’t pay your bills on time, bad things happen.”