Economists say the debt ceiling debate has already damaged the U.S. economy, and many worry that a deadlock could send the country hurtling into a double-dip recession.

"Growing uncertainty about the ultimate outcome inevitably has some negative effect on business capital investment and hiring as the August 2 deadline approaches," said David Crowe of the National Association of Home Builders.

So far, the damage has been fairly limited, with most economists surveyed by CNNMoney saying the debate has reduced the nation's gross domestic product by only a few tenths of a percentage point, at most, to date.

And economists generally aren't too worried about the economic impact of the U.S. briefly breaking past the Aug. 2 deadline.

"If a deal appears imminent, there will not be any impact on GDP," said Bill Watkins, executive director of the Center for Economic Research and Forecasting.

But the impact could be substantial if a prolonged battle prevents the government from sending out millions of checks owed to Social Security beneficiaries, federal employees, active-duty soldiers and other Americans dependent on government funds.

Economy still stuck in the mud

If the debt ceiling isn't raised, the federal government won't be able to pay 44% of its bills in August, worth an estimated $134 billion, according to a Bipartisan Policy Center analysis. That's the rough equivalent of cutting annual spending by $1.6 trillion -- enough to have a major effect on the economy.

But just how major?

One third of economists surveyed said a new recession is possible if there's a prolonged deadlock. And the threat is even greater because the economy is still healing from the last recession.

"It could precipitate a double-dip given that the economy is weak," said Watkins.

Some compared it to the financial meltdown in the fall of 2008 that turned a typical economic downturn into the Great Recession.

"If a default is allowed to occur, this would be the equivalent of self inflicting a financial crisis that is larger and more damaging than the one from which the economy is still struggling to recover," said Sean Snaith, professor of economics at the University of Central Florida.

Economists disagree on just how long past the deadline negotiators could go before triggering a recession. David Wyss, an economist at Brown University, said a couple of weeks of deadlock might not cause too much damage. But "if the problem extends, it probably means a return to recession with a negative third and fourth quarter."

But the majority of the 18 economists surveyed believe the economy will keep growing, albeit more slowly, even with a continued debt ceiling impasse.

A prolonged deadlock would shave a few points off of GDP for the rest of the year, but stop short of an actual recession, said David Nice of Mesirow Financial.

He doesn't think debt debate will drag on for too long, but if it does, he would cut the firm's forecast for economic growth roughly in half in the third quarter.

As we approach Treasury’s debt-ceiling deadline, attention has shifted from the risks of a default on Treasury debt to the risk of a downgrade of U.S. credit. Many are asking whether a downgrade could itself lead to a financial crisis. With the example of 2008 still fresh in many minds, the question has become: Would it be as bad as the Lehman Bros. bankruptcy?

Some market observers speculate that a downgrade would be a non-event: Japan, for example, went from a rating of AAA to AA without much drama. Others suggest that a downgrade would increase Treasury’s borrowing costs by $100 billion a year or more, making our already unsustainable deficit trajectory even worse.

There are no rules to define what is systemic and what isn’t — or to accurately predict the consequences of an economic shock. Each crisis is unique. How exactly it will affect financial markets, companies and our economy is impossible to know. Nonetheless, recent examples offer guidance.

In 2008, a number of once-cherished beliefs were turned upside down: (1) that home prices in America would never fall; (2) that AAA-rated subprime securities are sound; (3) that a major investment bank would never fail. Consumers, investors and companies allocated capital according to these truths. When the beliefs were revealed to be false, massive shocks were inflicted on the economy as financial markets rapidly adjusted to account for these new risks.

Banks had to reduce their leverage and rein in lending. Companies froze investment. Consumers cut spending and started saving. As a result, the economy plunged into recession, and millions of jobs were lost. Unemployment shot to 10 percent.

The question now is whether U.S. Treasury bonds, which anchor the global economy, really are the gold standard, the risk-free financial instruments they have been trusted to be. What will happen if that truth is revealed to be false?

Four factors in particular can help assess the magnitude of the financial impact from an undermined truth:

(1) How strongly is the belief held?

In 2008, investors around the world generally believed that major U.S. investment banks were so large they would never be allowed to fail. In the six months leading up to Lehman’s bankruptcy, however, it came under increased funding pressure and its stock price slowly collapsed. Markets were not completely convinced that the government would have the will or the ability to save Lehman; otherwise investors would have continued lending to it, as they did to Fannie Mae and Freddie Mac, which had no trouble borrowing money before they were rescued only days ahead of the Lehman bankruptcy.

By comparison, U.S. Treasurys have been defined for decades as the risk-free financial instrument throughout global financial markets. Faith in Treasurys is far stronger than it ever was in Lehman Bros. This suggests a far bigger shock than Lehman if this truth is proven false.

(2) How big an asset class does the belief support?

U.S. Treasurys are a $14 trillion market — the single biggest security market in the global economy. In comparison, Lehman had approximately $600 billion of liabilities before it failed, less than 5 percent of the size of the Treasury market. Treasurys are held by virtually all 8,000 banks in America and nearly all insurance companies, corporations, pension plans and millions of individuals’ 401(k)s. This scale suggests a far larger shock than Lehman.

(3) How wrong was the belief?

Here, Treasurys are not as bad as Lehman. Even if the U.S. credit rating is downgraded, almost no one believes we will actually default on our debt. The United States is not entering bankruptcy, and its debt is not junk. Lehman debt ultimately proved to be worth a fraction of its face value. To some, this suggests a U.S. downgrade would produce a more modest shock than Lehman. But a small deviation from a cherished belief can be as shocking as a large deviation from a weaker belief.

(4) What is the economic context in which the shock is taking place?

Although the United States is technically no longer in recession, the U.S. economy is growing slowly. Unemployment remains at 9.2 percent. Europe is awash in its own fiscal crisis, and much of the developed world is struggling. When Lehman collapsed, U.S. unemployment was at 6 percent, but the economy was contracting and housing markets were plummeting. The global economic context in September 2008 was probably worse than today, but our economy remains vulnerable.

These factors suggest that a U.S. downgrade has the potential to be as bad or perhaps worse than the Lehman shock. The more strongly held a belief, and the larger the asset class it supports, the greater the potential damage to the economy when the belief is turned upside down. We may not be certain what will happen if U.S. credit is downgraded, but there is no upside to finding out.

The writer, a managing director of the investment management firm Pimco, served as an assistant Treasury secretary during the George W. Bush administration. He established and led the Office of Financial Stability and the Troubled Assets Relief Program until May 2009.

This cartoon by Schrank from The Independent on Sunday shows German Chancellor Angela Merkel and French President Nicolas Sarkozy relaxing on a pier in the shape of Europe, while Barack Obama surfs towards them on a giant wave marked 'U.S. Debt Crisis'.

COMMENTARY

Merkel and Sarkozy might have thought that they had earned a holiday after coming up with a second Greek rescue package (the newspaper headline reads "Greece bailed out again"), but the European pier (i.e., economy) looks decidedly rickety and risks being engulfed by the looming U.S. debt crisis. An American default would have disastrous consequences not only for the U.S. but the world economy, possibly starting a new recession.

The nation is just days away from the debt ceiling deadline, and no one knows exactly what will happen when the borrowing limit is reached. But even in the worst case scenarios, many experts think investors will flock to U.S. Treasuries.

That possibility would mean lower borrowing costs for the government, not the spike in interest rates that many were expecting.

"Intuitively, this might not make sense because you would think there would be selling of Treasuries, but instead the Treasury market is well-supported," said Richard Bryant, head of Treasury trading at MF Global.

The experts admit they're not sure how markets will react if there is no solution by the Aug. 2 deadline. But many believe that stocks will suffer more in the uncertainty caused by a debt ceiling crisis.

"We'll have a liquidation of risky assets and a flight into quality," said Kim Rupert, Managing director of Fixed Income for Action Economics. "There really isn't an alternative [to Treasuries]."

Market news

U.S. Treasuries are such a massive market -- about $9.8 trillion -- that they dwarf the markets of other so-called "safe havens" such as gold, top-rated corporate debt or the bonds of other countries with AAA ratings.

And the expectation that the U.S. Treasury will continue to pay the principal and interest payments owed on existing debt, even in the case of a prolonged deadlock, will give investors a sense of confidence, even if there is a downgrade.

"I don't think a rating change will fundamentally change anyone's view about the likelihood of being paid back on Treasuries," said Josh Fienman, chief economist DB Advisors. "They will continue to think that Treasuries are 'money- good.'"

Fienman said that the U.S. debt ceiling crisis is widely viewed as less serious than the lingering worries about European sovereign debt. He said the U.S. needs to address its long-term government deficits, but that is a problem that needs to be solved in the coming decades, not coming days.

"This is a self-inflicted crisis. No one in the market is unwilling to lend to the U.S., " he said. "Some people find it galling, but no matter what the U.S. does, it's able to borrow at extraordinarily low interest rates."

Some worry about whether foreign investors will sour on U.S. Treasuries if there is a crisis. But countries with huge holdings of U.S. debt, such as China, have an interest in making sure that bonds stay strong during a debt ceiling crisis so as not to hurt the value of their existing holdings.

"We suspect that China would quickly pledge to continue purchases of Treasury securities, just as it has done for debt issued by governments in the eurozone, given the even greater risks to its own wealth from a financial meltdown in the U.S.," said Julian Jessop Chief International Economist for Capital Economics in a note Thursday. "China's own rating is currently AA-, so it would be odd for Beijing to make a big deal of a downgrade that would almost certainly still leave the U.S. rating higher.

A prolonged debt ceiling deadlock could quickly cause the government to stop making other payments , cutting paychecks to federal workers, contractors and citizens depending on payments such as Social Security.

Analysis by the Bipartisan Policy Center estimates that cut in spending could come to $134 billion in August alone, roughly the equivalent of cutting annual spending by $1.6 trillion. And that slashing in spending has many economists worried that the crisis could spark a new recession.

But a recession, while terrible for stocks and a country as a whole, can be good for bond prices, which move in the opposite direction of bond yields. Lower inflation expectations that typically accompany a recession lowers the returns that investors demand on a nation's debt.

The record low yield for the 10-year Treasury of just above 2% came in December 2008, when the country teetered on the edge of a new depression. Rupert said yields could approach those lows, nearly a full percentage point below current levels, if another recession starts.

One other factor that could lift bond prices is that Treasury could be forced to stop selling new bonds, which would limit the supply available for investors. Limiting supply typically helps to lift prices.

Thursday's auction of 7-year Treasuries came in with a yield of 2.25%, the lowest rate Treasury has had to pay for notes of that term since last November.

A bipartisan group of U.S. senators on Tuesday revived an ambitious budget plan that could provide new ideas for breaking the impasse in Congress over raising the nation's credit limit by August 2.

President Barack Obama threw his support behind the proposal by the "Gang of Six" senators, saying it was broadly consistent with his approach on reducing debt and deficits.

Obama urged Senate Majority Leader Harry Reid, a fellow Democrat, and Senate Republican leader Mitch McConnell to start "talking turkey" about it.

Senate Budget Committee Chairman Kent Conrad, one of the six Democratic and Republican senators who have been working since December on a deficit-reduction plan, said the proposed $3.75 trillion in savings over 10 years contains $1.2 trillion in new revenues.

The group briefed about half of the 100-member Senate and "the response was very favorable," Conrad told reporters.

He said the group asked fellow senators to take 24 hours to look at the proposal and "report back to us."

According to an executive summary of the plan, it would immediately impose $500 billion in deficit cuts, cut security and non-security spending over 10 years with spending caps, make the Medicare and Medicaid healthcare programs operate more efficiently and abolish the Alternative Minimum Tax.

Asked whether the plan could become part of urgent negotiations that link deficit reduction to raising the U.S. government's borrowing authority by August 2, Conrad said: "Could the two get married? Could they get combined at some point? I'm sure that's possible."

But leaders must first find out whether the proposal has enough support in the Senate, he said.

But a senior Senate Democratic aide said, for now, "there are no discussions" on incorporating Gang of Six ideas into legislation to raise the debt limit beyond $14.3 trillion.

TAXES AT ISSUE

Conrad was quick to say that while there are $1.2 trillion in new revenues, the overall plan envisions a $1.5 trillion tax cut that would be achieved through broad tax reforms.

Most Republicans, especially Tea Party members in the House of Representatives, have vowed to block any revenue increases.

The Senate group's hope has been that if the three conservative Republican members embrace revenue increases, the idea could catch fire among other Republicans in the Senate and House -- especially if popular but expensive entitlement programs such as Medicare also shoulder some cuts.

In another politically risky move, the Gang of Six plan would achieve significant savings in healthcare programs, Conrad said. The specific spending cuts would be decided later by congressional committees.

Conrad said a separate measure would reform the Social Security retirement program to stabilize its finances for the next 75 years.

The effort got a boost as conservative Republican Senator Tom Coburn rejoined the group after taking a "sabbatical" in mid-May amid heavy disagreement over Medicare spending cuts. It was not yet clear how Coburn's concerns have since been addressed.

On Monday, Coburn unveiled his own plan to cut $9 trillion in deficits over a decade, including nearly $1 trillion in revenue increases.

Revenue proposals are not likely to include income tax rate increases. Instead, they could center on repealing or rolling back special tax favors such as those for ethanol blenders and companies that operate corporate jets, as well as preferential tax treatment for fund managers.

Those specific decisions likely would be up to House and Senate tax-writing committees, along with broader tax reform questions.

The debt ceiling talks, for weeks now, have been going on behind closed doors. The negotiations have been conducted by a tiny group of legislative leaders and President Obama's top aides.
All the while, the countdown to Aug. 2, when the government will no longer be able to pay all its bills, has marched closer.

Any proposal will still have to be put into legislative language, scored by the Congressional Budget Office and vetted by rank-and-file lawmakers whose votes will decide its fate.

Even after the principal negotiators announce a deal, the rest of Congress will have to be convinced to go along. The closer to D-Day Washington gets, the messier it will be.

Witness what happened on Sept. 29, 2008, when the House at first rejected the $700 billion bank bailout bill.

Weeks earlier, Fannie Mae and Freddie Mac had been placed into conservatorship by the Treasury Department. Lehman Brothers had filed for bankruptcy. AIG Corp, the world's biggest insurer, had been bailed out by the Federal Reserve.

After all that, the Senate passed the bill. And then, as markets watched, the measure was voted down in the House -- a defeat that shocked investors and congressional leaders on both sides of the aisle.

Debt ceiling: What happens if Congress doesn't raise it?

Following the vote, the Dow slumped 778 points, in the biggest single-day point loss ever.
A few days later, the House reversed course and passed a modified version of the bill. Some 58 members switched their votes.

Why was the process so hard? A principal reason is that it was rushed.

Lawmakers who voted against the bill warned that "being stampeded" into a decision would be a serious mistake.

"Wall Street is so hungry for the $700 billion they can taste it. To get it they need to ... create panic, block alternatives and herd the cattle. We ask Congress not to rush," California Democrat

Rep. Brad Sherman said before the vote.

"I am voting against this today because it's not the best bill. It's the quickest bill," Rep. Marilyn Musgrave, Republican of Colorado, told the New York Times. "Taxpayers for generations will pay for our haste and there is no guarantee that they will ever see the benefits."

Norman Ornstein, a resident scholar at the American Enterprise Institute, said lawmakers now face a similar situation, but this time around, "It's worse."

Lawmakers aren't going to have a lot of time to consider their options. And all the negotiations are happening behind closed doors, limiting the involvement of rank-and-file members.

"With TARP, it wasn't clear that another day or two wouldn't make a big difference," Ornstein said. "If you take two to three days messing around with this, you end up with what could be a profound and very long lasting impact."

The White House has already warned that time is running short, saying that a deal needs to be completed in the next couple days in order to give Congress time to pass a bill.

Alabama Republican Sen. Jeff Sessions has voiced concern about the timeline, saying there is a "very real risk that no text will be available until the last minute" and that a bare minimum of seven days is needed to review legislation.

How Washington screwed up the budget

"The real endgame here is not August 2," Ornstein said. "It takes time to put any agreement into legislative language and get it scored. It sure as hell doesn't look to me like we are urgently moving to make sure that happens."

And like 2008, not everyone is dealing with the same set of facts. At that time, every high-ranking government official from then-President Bush on down was warning of dire consequences if TARP faltered in the House.

That moved a few members into the "yes" column, but not all.

"We're on the cusp of a complete catastrophic credit meltdown. There is no liquidity in the market," Rep. Sue Myrick, a North Carolina Republican, said in a statement before the vote. "We are out of time. Either you believe that fact, or you don't. I do."

Right now, despite warnings from Treasury Secretary Tim Geithner, President Obama, Federal Reserve Chairman Ben Bernanke and even House Speaker John Boehner, a number of Republicans remain so-called debt ceiling deniers.

"You've got enough people out there, way too many people, who aren't going to be convinced until Armageddon actually happens," Ornstein said.

U.S. lawmakers got another stern warning from a leading credit rating agency on Thursday that there is now a very real possibility that the country's top-notch credit rating could be downgraded in the next three months.

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Standard & Poors said in a statement it was placing the United States' sovereign rating on "CreditWatch with negative implications."

"[O]wing to the dynamics of the political debate on the debt ceiling, there is at least a one-in-two likelihood that we could lower the long-term rating on the U.S. within the next 90 days," the agency said in a statement.

The action on Thursday follows a move in April when S&P changed its outlook on the U.S. AAA rating to "negative" because at the time it couldn't see how lawmakers would create a path to real debt reduction.

Bernanke: Debt ceiling breach 'calamitous'

Since then "the political debate about the U.S.' fiscal stance and the related issue of the U.S. government debt ceiling has, in our view, only become more entangled," the agency said.

"[W]e believe there is an increasing risk of a substantial policy stalemate enduring beyond any near-term agreement to raise the debt ceiling," S&P noted.

Indeed, other warnings from ratings agencies Moody's and Fitch in the interim spurred more rhetoric than action from politicians. Seven weeks' worth of talks between the parties led by Vice President Joe Biden broke down in June after House Majority Leader Eric Cantor left the negotiations.

And regular meetings at the White House between President Obama and Capitol Hill brass over the past two weeks have showed no signs of real progress. Obama will hold a press conference Friday to offer an update on the negotiations.

A downgrade of U.S. credit would mean interest rates on U.S. bonds would go up. And it could have ramifications across global markets because U.S. bonds are considered the world's safe haven investment.

The Treasury issued an immediate response to the news.

"Today's action by S&P restates what the Obama Administration has said for some time: That Congress must act expeditiously to avoid defaulting on the country's obligations and to enact a credible deficit reduction plan that commands bipartisan support," Treasury official Jeffrey Goldstein said. (Read: Republican stance on taxes a bust with public)

A downgrade could come for one of three reasons, S&P explained:

-- If Congress and the administration fail to come up with a "credible solution" to U.S. debt and show no signs of agreeing on one in the foreseeable future.

-- If the United States misses any scheduled debt service payments, in which case S&P would issue a "selective default" meaning a default has occurred on some bonds but not others.

-- If S&P concludes that the debt ceiling debate so bogs down that it calls into question policymakers' "willingness and ability to timely honor the U.S.' scheduled debt obligations."

Treasury started sending letters to Congress back in January urging them to raise the $14.3 trillion debt ceiling -- which is the U.S. legal borrowing limit

The Treasury takes in, on average, about $125 billion less than it has to pay out on a monthly basis. To make up the difference it issues U.S. bonds, and because of the country's sterling rating, it is able to do so at very low rates.

If Congress doesn't raise the debt ceiling by Aug. 2, the Treasury will no longer be able to pay all of the country's bills in full and on time without interruption

How much clearer can Ben Bernanke be?

The Federal Reserve Chairman has issued a stern warning to Congress repeatedly this year: if it fails to raise the U.S. debt ceiling by Aug. 2, the economic fallout could be "catastrophic," "self defeating" and "dire."

And yet, here we are in mid-July, with the country only three weeks away from a possible default, and Bernanke is repeating his warning again -- this time in his semi-annual monetary policy report to Congress.

"Clearly, if we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world," Bernanke said, indicating such an event would raise interest rates and send shockwaves rippling through the entire global system.

And contrary to what some Republicans have proposed, just paying interest on the debt to bondholders may not preserve the nation's pristine credit rating, Bernanke said.

"It's possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive, of course, since it makes the deficit worse," he said.
Debt ceiling: Chaos if Congress blows it

If Congress does not pass the debt ceiling by Aug. 2, the Treasury Department will not be able to pay at least 40% of its bills -- possibly including payments to Social Security recipients and military pay.

Bernanke also indicated the U.S. economy is at a crossroads, and the central bank is prepared to either provide further stimulus or pull back from intervening.

"On the one hand, the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support," he said in prepared testimony, indicating the Fed stands ready to provide additional stimulus if the recovery falters.

While those remarks immediately gave U.S. stocks a boost, the Fed chairman was quick to follow up that statement with a completely opposite idea -- showing it's not really clear which direction the economic recovery is heading right now.

"On the other hand, the economy could evolve in a way that would warrant a move toward less-accommodative policy," he said.

From November until June, the Fed bought $600 billion in U.S. Treasuries as a way to boost the economic recovery.

Amid disappointing jobs reports in May and June, and other weak readings on the economy, critics have questioned whether that controversial policy -- known as the second round of quantitative easing, or QE2 for short -- has actually worked.
Debt ceiling: What you need to know

Bernanke cited statistics that private businesses have averaged 160,000 jobs created each month in 2011, and part of that could be due to QE2.

That said, the Fed is maintaining its weak forecasts for the year overall, expecting the economy to grow by only 2.7% to 2.9% in 2011.

Meanwhile, inflation remains a concern, Bernanke said. He had previously argued that higher consumer prices are merely "transitory", but he changed his tune slightly Wednesday and seemed more vigilant of inflationary pressures.

"Given the range of uncertainties about the strength of the recovery and prospects for inflation over the medium term, the Federal Reserve remains prepared to respond should economic developments indicate that an adjustment in the stance of monetary policy would be appropriate," he said.

The public pressure on lawmakers to raise the debt ceiling was ratcheted up Wednesday when a major rating agency said it would put the sterling bond rating of the United States on review for possible downgrade.

Moody's Investors Services said it had initiated the review because of "the rising possibility" that Congress will fail to raise the debt ceiling by Aug. 2 -- something that could lead to a U.S. default on its debt.

If the debt ceiling isn't raised by then, the Treasury Department says it will no longer be able to pay all the country's bills in full and on time without being allowed to borrow new money. (Read: Debt ceiling FAQ)

"Moody's considers the probability of a default on interest payments to be low but no longer to be de minimis," Moody's said in a statement.

The United States enjoys its AAA rating in part for having always stood behind its debt and paid its bills on time. As a result, U.S. Treasury bonds are considered the world's safe-haven investment.

The Treasury Department issued an immediate response Wednesday.

"Moody's assessment is a timely reminder of the need for Congress to move quickly to avoid defaulting on the country's obligations and agree upon a substantial deficit reduction package," Treasury official Jeffrey A. Goldstein said in a statement.
Debt ceiling: Chaos if Congress blows it

In the still unlikely event the United States would default on any of its interest payments to bondholders, Moody's said it expected the default to be short-lived and the loss to bondholders "minimal or non-existent."

But, the agency added, a default "would fundamentally alter Moody's assessment of the timeliness of future payments." Translation: The United States would be downgraded to AA status.

Beyond the debt ceiling: Even if lawmakers raise the debt ceiling in time, Moody's also made clear that it is expecting progress on the long-term debt.

The agency said it would likely change its outlook on the AAA rating to "negative" from "stable" absent a "substantial and credible" debt-reduction deal.

Moody's had alerted investors in early June that it was considering putting the U.S. rating under review unless it saw forward movement in the debt talks by mid-July. It cited as a concern the "heightened polarization" in the debate.

Since then, negotiations led by Vice President Biden to find a compromise broke down and the prospects for a "grand bargain" have been called into question.

Market reaction: Just how the bond market -- i.e., the investors around the world who lend to the federal government -- will respond to Moody's action is not clear yet.

Bond traders may take note but not blink since the agency already signaled its intention -- "so no surprise factor," said Steve Van Order, a fixed income strategist at Calvert Investments.

And Moody's isn't the ultimate arbiter.

"The bond market will follow its own judgment of how Washington is approaching deficit reduction, not the decisions of the rating agencies," said Jim Vogel, head of interest rate strategies at of FTN Financial.

But, Vogel noted, "Moody's action will focus the market's attention on the debt ceiling more than it has been in recent days. Rating agency actions also may provide a rationale for policy makers to alter their voting stance as deadlines loom."
Bernanke: Default would cause 'major crisis'

Moody's isn't the first ratings agency to announce a negative action.

In April, Standard & Poor's revised its outlook on the country's AAA rating to negative from stable.

S&P's reason: Relative to its peers, the United States has "very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us."

Fitch Ratings, meanwhile, said in early June that if lawmakers fail to raise the debt ceiling by Aug. 2, it would put the country on "ratings watch negative," meaning there is a "heightened probability" of a rating change.

Timothy Geithner said Thursday that he plans to stay on as Treasury Secretary for the foreseeable future. But that hasn't stopped speculation about who might take his place later this year.

Sources told CNN and other news outlets Thursday that Geithner is considering leaving the Obama administration later this year, once negotiations on raising the government's debt ceiling and cutting the budget deficit are complete.

Geithner's family is moving back to the New York suburbs where they lived before he took office so his son can finish high school there. And as the head of Treasury through the worst financial crisis in a generation, and the last key member of President Obama's original economic team still on the job, a desire to leave wouldn't be a shock.

Geithner tried to tamp down the reports of his imminent departure when speaking in Chicago Thursday by saying he wasn't planning on leaving anytime soon.

Still, economists and Washington experts were already talking about who might take over the high-profile job.

Near the top of the list is current White House Chief of Staff Bill Daley, a close Obama confidant and someone who was brought in at least partly because of his good relationship with the business community.

Before taking the job in the administration earlier this year, Daley had been an executive at JPMorgan Chase (JPM, Fortune 500). He also served as Secretary of Commerce in the second term of the Clinton Administration.

Also at the top of many lists is Erskine Bowles, the Democratic co-chairman of the president's bipartisan commission on cutting the budget deficit. Bowles, who had served as White House Chief of Staff in the Clinton administration, would be an relatively easy pick to get confirmed given the budget cutting emphasis in Congress today, according some experts.

But when contacted Friday, Bowles, 65, appeared to take himself out of running for the job, saying that he is not interested in any full-time job at this point in his career.

"I am looking forward to being useful in part-time endeavors," he said.

Investment banker Roger Altman is another name that has been mentioned, but his name has surfaced for previous openings on the Obama economic team without ever getting tapped for a position.

And White House Budget Director Jacob Lew, who has been central to negotiations on the debt ceiling and deficit reduction, is another name suggested by experts.

Jamie Dimon, chairman and CEO of JPMorgan Chase, who is often described as "Obama's favorite banker" is another prominent name mentioned. A spokesman for the nation's second largest bank holding company had no comment on whether his boss would be interested in the job.

Greg Valliere, chief political strategist, Potomac Research Group, said he doesn't think it'll be a good idea for Obama to pick someone from Wall Street, given the government help banking giants like JPMorgan -- along with rivals likeCitigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) -- received during the crisis three years ago.

"I just think that Wall Street is not the way they would go. It could be an albatross for this administration," said Valliere. "And having him berating [Federal Reserve Chairman Ben] Bernanke in public three weeks ago certainly didn't help his case."

Valliere said that he thinks Obama should try to go with a high-profile Treasury Secretary outside of banking and Washington -- someone like Berkshire Hathaway (BRKA, Fortune 500) Chairman Warren Buffett, an earlier supporter of Obama four years ago, or New York Mayor Michael Bloomberg.

"I think he should do something bold and swing for the fences. I think Mike Bloomberg would be an electrifying pick," he said. "The only problem is that he could stray from the reservation on the message. But he's an entrepreneur who knows about creating jobs."

Bloomberg has denied interest in an administration post in the past, and has said he intends to complete his term as mayor which runs through 2013. A spokesman in the mayor's press office declined to comment Friday.

But the political reality is that it might be impossible to get any replacement for Geithner confirmed by the Senate in the year before a presidential election, said Jaret Seiberg, a research analyst at MF Global Inc.'s Washington Research Group.

Seiberg pointed out that 44 Republican senators have vowed not to confirm any nominee to head the new Consumer Financial Protection Bureau because they want the new agency's powers substantially trimmed. The same political battle could lead that group to block a Treasury nominee as well, he said. Even Alexander Hamilton would have trouble getting confirmed today, he said.

"The problem is there is no ideal candidate out there," said Seiberg. "I think it's a Herculean task to get anyone through the Senate right now. That's why at the end of the day, we're likely to have Geithner stay in place."

Valliere said if confirmation becomes the major hurdle to a new Treasury chief, he could see Secretary of State Hillary Clinton moving over to Treasury, with Sen. John Kerry taking her spot at State. Past and current senators have an easier time winning confirmation than do outsiders, he said. And he said that the Treasury job has become a diplomatic job as much as a finance job in the current interconnected global economy

Tim Geithner is considering leaving his post as Secretary of the Treasury after a deal to raise the debt ceiling is reached, a source familiar with the discussion told CNN Thursday.

Geithner is the lone remaining member of President Obama's original economic team.

Asked by former President Bill Clinton on Thursday at a Clinton Global Initiative event about his future plans, Geithner said he would be doing his job "for the foreseeable future."

A Treasury official said that Geithner will not make any decisions while he's focused on negotiations over the debt limit and deficit reduction.

Another source familiar with the discussions between Geithner and the White House said it could be a while before Geithner's ultimate departure. "You have to have somebody lined up for the job -- you can't just leave," this source said. "And there's a relative scarcity of people who would fit the bill."

Obama nominated Geithner to be the 75th Secretary of the Treasury, and the Senate confirmed him on Jan. 26, 2009.

Geithner went on to spearhead the administration's response to the financial crisis that threatened to unravel economic growth around the globe.

That response included a bailout of the U.S. auto industry, a massive economic stimulus package and a landmark Wall Street reform effort. So-called stress tests of the nation's largest banks in early 2009 also helped shore up confidence in financial markets.

Geithner's first days in the administration were not without stumbles, as markets met his efforts to support the banking industry with skepticism, and giant bonuses paid to executives at bailed-out insurer AIG sparked public outrage.

But Geithner emerged as one of the strongest voices on Obama's economic team.

"I think he has done a great job in a backbreaking position," Clinton said Thursday.

Another member of Obama's original team, Council of Economic Advisers chairman Austan Goolsbee, has said he will leave the administration in August to return to the University of Chicago.

That leaves the administration with two holes to fill in the months leading into the 2012 presidential race, where the economy is expected to be issue No. 1.

National Economic Council director Lawrence Summers, and Office of Management director Peter Orszag left the administration last year. Christina Romer, the original chair of the Council of Economic Advisers, has also left.

Before joining the administration, Geithner held the top post at the Federal Reserve Bank of New York, where he played a crucial advisory role during the financial crisis of 2008.

Before joining the Fed, he held posts at the IMF and worked in the Clinton administration Treasury Department.

QE2 is just about done. But the Federal Reserve will still be buying massive amounts of long-term Treasuries.

In fact, the Fed's purchases over the next year will likely be at least $300 billion. That's half the size of QE2 -- even if QE3 never takes place.

While the Fed's efforts to pump about $600 billion of new cash into the economy over the last eight months comes to an end this week, the program, known as quantitative easing or QE2 for short, was not the only way the central bank was an active buyer of Treasuries.

Since last August, the Fed purchased $250 billion in long-term Treasuries in addition to the QE2 purchases. That's because it was reinvesting the principal from other securities that matured.

Assuming the Fed keeps reinvesting, as it said it would earlier this month, it will continue to be a very big buyer of bonds in the months to come.

"We still see the Fed being a major buyer of Treasuries, and giving the market some support," said Kim Rupert, managing director of fixed income for Action Economics.

But those purchases may not push yields, which move in the opposite direction of their price, lower for that much longer.

Rupert said she expects bond yields to rise even with the Fed's continued purchases. She said some investors who bought Treasuries recently in a flight to quality will unwind those positions. If the economic outlook improves later in the year, that could also lift interest rates.

The additional Fed purchases will have an impact though. Rupert said it should "slow the updraft in yields in a measurable way."

The Fed still has more than $1 trillion in mortgage-backed securities, debt issued by government-sponsored firms Fannie Mae and Freddie Mac and other long-term bonds on its balance sheet.

While not all of this debt is set to mature in the next few months, the Fed still has a lot at its disposal to roll over into new bond purchases.

Of course the Fed could decide to stop reinvesting the principal of maturing securities. But that could almost have the same effect of actually raising interest rates. It would take significant amounts of cash out of the economy.

Even though some Fed policymakers are worried about the impact the bond buying has had on the dollar and inflation, the Fed does not seem ready to remove all its stimulus just yet. After all, the central bank did just issue a gloomier forecast for growth and unemployment through the end of 2012.

"Most of us can agree the economy is not going gangbusters and it's not a self-sustaining recovery yet," said David Coard, director of fixed income sales and trading for The Williams Capital Group. "For the foreseeable future, the Fed will have to maintain an accommodative stance. It's the only game in town."

U.S. Treasury Secretary Tim Geithner said Tuesday that he supports French finance minister Christine Lagarde as head of the International Monetary Fund.

"Minister Lagarde's exceptional talent and broad experience will provide invaluable leadership for this indispensable institution at a critical time for the global economy," Geithner said in a statement.

The global financial organization is expected to vote on a new managing director as early as Tuesday to replace Dominique Strauss-Kahn, who was arrested in New York last month on sexual assault charges.

The vote on whom to appoint to the influential post comes at a crucial time for the IMF, which has been working closely with the European Union and the European Central Bank to provide financial support for Greece and other troubled European economies.

The only other contender is Mexican Central Bank chief Agustin Carstens, who has been supported by Australia, Canada and Mexico.

Geithner commended Carstens "on his strong and very credible candidacy."

Lagarde, who would be the first woman to run the IMF, is also backed by the United Kingdom, Germany and most European powers. Some Asian and African nations have also signaled support for her candidacy.

The fund's 24-member executive board seeks to agree on a new managing director by consensus.

The IMF, which is made up of 187 member countries, has traditionally been led by a Western European official.

For Greece, the real challenge is still ahead

Some developing nations had pushed to break that tradition, arguing that the IMF should consider candidates from rising economic powers in Asia and South America.

In a statement to the IMF's executive board released last week, Lagarde said the fund "belongs to no one but its 187 member states."

"I am not here to represent the interest of any given region of the world, but rather the entire membership," she continued.

The fund was established in 1947 to help rebuild the international monetary system after World War II. In addition to monetary cooperation and exchange rate stability, the IMF works to facilitate international trade and promote economic growth around the world.

The IMF has been led by John Lipsky, a veteran deputy managing director, since May 19.

Strauss-Khan pleaded not guilty earlier this month to seven charges involving a May 14 incident in which a housekeeping employee at New York's Sofitel hotel accused him of sexual assault.

Once considered a top candidate in France's next presidential race, Strauss-Khan officially resigned from the IMF on May 19. He is being held under house arrest in a Manhattan apartment on $6 million in bail money.

Warnings from all three credit ratings agencies didn't do it. Seven weeks of talks among lawmakers didn't do it. Maybe President Obama's talks with Capitol Hill brass will do it.

But as of now, there's still no debt-reduction deal. And many lawmakers are still demanding one in exchange for their vote to increase the debt ceiling.

Here's an idea: Even if they can't come up with a deal by Aug. 2, lawmakers should raise the debt ceiling anyway. Then they should make a pot of coffee and go back to hammering out a debt-reduction plan.

Fiscal responsibility isn't a one-off proposition; it's an ongoing process.

If Congress fails to raise the debt ceiling by Aug. 2 -- the day when the Treasury Department estimates it will no longer be able to pay all the country's bills -- any number of damaging and utterly preventable scenarios could occur.

Deadbeat nation: For starters, the United States would look ridiculous. The debt ceiling needs to be raised because of obligations that Congresses past and present chose to incur.

Not raising the ceiling would signal to the world that Americans are willfully choosing not to pay their bills. The message won't be "We can't pay." It will be "We could pay, but we've decided not to. Sorry."

Market mayhem: To date, investors have been trading on the assumption -- the rock-solid belief, actually -- that there is just no way Congress would fail to raise the debt ceiling in time.

If Congress dashes those expectations, no one can know exactly how the markets will react. But most think markets will react, and not well.

Some bond experts expect that contrary to popular belief, Treasury rates won't rise but stocks may tank. In other words, there will be a move out of risk-based assets and a flight to safety in bonds.

Bond experts to Congress: Don't mess it up

So interest rates may stay low, but Americans' investments get whacked.

Or, Treasury yields could become volatile and start to climb as investors smell political instability in Washington. That would push the cost of U.S. debt higher.

Hopping mad republic: If Treasury is technically and legally able to prioritize the payment of interest to bond investors, the country may avoid the kind of default that would trigger rating downgrades.

A growing number of lawmakers say that it's OK not to raise the debt ceiling as long as Treasury continues to make payments to bondholders.

But that doesn't mean there wouldn't be seriously negative consequences.

"Someone -- perhaps millions of someones -- won't be paid on time. Contractors, federal workers, program beneficiaries, or state and local governments will suddenly find themselves short on their cash flow," former Congressional Budget Office Donald Marron wrote in a recent op-ed in the Christian Science Monitor.

That could hurt the economy, which is still trying to find its sea legs, and won't do much for the country's mood.

Damaged reputation: Even if bond investors continue to be paid, investors and credit rating agencies won't take it lightly when Treasury has to delay payments to others.

Such delayed payments -- and the public anger that would result -- could cause investors to worry that even if they're getting paid today, tomorrow may be another story. And they could trade on that concern, even if it's unfounded. That, in turn, could cause interest rates to rise.

Fitch Ratings Agency said it would put the country on "Ratings Watch Negative" in such a scenario.

"Extensive payment arrears to suppliers of goods and services to the government ... would damage perceptions of U.S. sovereign creditworthiness and signal growing financial distress," the agency said in a recent report.

The S&P already has already downgraded its credit outlook on the United States to "negative" from "stable." And Moody's is considering doing the same.

Downright default: This is the very worst and still least likely of outcomes, because most believe that there's no way the U.S. government would not pay its bondholders.

But if they don't raise the ceiling, lawmakers would raise the chance that those bondholders don't get paid over time.

Debt ceiling: What you need to know

That could theoretically happen if the Treasury a) is somehow not able to prioritize payments to bondholders; or b) has to pay out more to bondholders than it has coming in on any given day.

On some days Treasury brings in more money than it has to pay out. And on some days it doesn't. But on average, the United States comes up short by about $125 billion every month.

To cut that much spending or raise that much extra in tax revenue overnight would hobble the U.S. economy and very likely de-stabilize world markets.

A U.S. default would be catastrophic, influential bond investor Mohamed El-Erian said Sunday on CNN's "Fareed Zakaria GPS."

His advice to Congress? Raise the ceiling, even if you can't complete a debt-reduction deal in time.

"If ... you're going to kick the can down the road, kick the can rather than face something that could be catastrophic in terms of legal contracts being triggered," said El-Erian, CEO of PIMCO