Random Views on U.S. Default

From WSJ Washington Wire:

Mark Zandi, chief economist of Moody’s Analytics, said the market impact of failing to raise the $14.29 trillion debt ceiling by Aug. 2 could become severe by late July.

At a breakfast hosted by the Christian Science Monitor, here’s how Mr. Zandi told reporters things could play out.

“I think if we get on the other side of July, particularly as we move to the second and third week of July and nothing is happening, if the world looks like it is today, I think people are going to start getting nervous one investor at a time. And it’s going to start showing up in rising bond yields, a weakening equity market. Then all of the sudden we’re going to get to a day when we’re going to get a critical mass of investors saying, ‘You know what, this may not happen, we better attach a probability to an Aug. 2 misstep.’ And markets are going to start going south. And of course the rating agencies are going to start responding too…so if, we get to the end of July, I think the policy makers will see it quite clearly.”

He said if the ceiling isn’t raised by Aug. 2, “it’s going to be a TARP moment,” referring to the day in late 2008 when the House of Representatives voted down the creation of the $700 billion Troubled Asset Relief Program and stock markets plummeted.

And then what?

“The dark scenario is so dark I can’t imagine it,” he said.

As Republican leaders indicate tax revenues are off the table, so that all deficit reductions have to be derived from spending cuts EK, this scenario seems ever more plausible.

I think the TARP analogy is particularly apt. Just to remind readers, here is an excerpt from Lost Decades, coming out in September:

By the end of the day of the vote, the Dow Jones had 214 dropped over 770 points, its largest ever one-day drop in points — wiping out about $1.2 trillion dollars worth of stock value. … The TED spread [which] was hovering around 1 percent … rocketed above 3 percent, and it kept going, to an unprecedented maximum of 3.87 percent. …”

Here’s a graphical depiction of the drop in equity prices.

Figure 1: Dow Jones Industrial Averages, 9/15/2008-10/20/2008. Source: St. Louis Fed FREDII.

I thought it is of interest to see what the Kauffman survey of bloggers thought should be done, with respect to the debt ceiling.

Figure 2: from Kauffman Economic Outlook: A Quarterly Survey of Leading Economics Bloggers, Second Quarter 2011

In any case, I agree with Jim, for the sake of the country, the debt ceiling is the wrong place to draw a line in the sand. Saying that all deficit reduction must come from spending reductions, and none from tax revenue increases is the heighth of irresponsibility. (Others agree, even if even the default is “small” — see here. Some estimates of the impact on spreads here).

Update: 7pm Pacific More from Stan Collender at Capital Gains and Games.

This post originally appeared at Econbrowser and is reproduced here with permission.