That Time in 1979 When the U.S. Government Defaulted

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As the Congressional debate over the debt ceiling rages on this week, more analysts are raising the question of what would happen if the country defaults on U.S. Treasury bonds. For finance types, the notion of the U.S. government defaulting is nearly unthinkable; Treasury securities are considered to be effectively risk-free. Murmurs that the ongoing wrangling over the debt ceiling could lead to even a brief default have provoked plenty of worrying on both sides of the congressional aisle. Could the government really default?

It sure could. It’s happened before!

In the spring of 1979, Congress was in the midst of a similarly heated debate about raising the debt ceiling, Legislators eventually reached a last-minute deal to raise the debt ceiling and (they thought) save the day, but something went wrong. The Treasury didn’t redeem $120 million worth of securities that matured in April and May.

In other words, the U.S. Treasury defaulted on its securities even though Congress settled the debt-ceiling issue. What happened? It’s not totally clear.

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Ball State University finance professor Terry Zivney later co-authored a paper entitled “The Day the United States Defaulted on Treasury Bills,” and when he appeared on NPR’s All Things Considered earlier this month, he admitted the default was still a bit of a mystery even to him.

By all indications, the 1979 default seems to have been the result of a run of bad luck. The deal over the debt ceiling was a decidedly eleventh-hour affair, and when it sparked a run on Treasury securities by investors, the department got backlogged on its paperwork. Moreover, the Treasury later explained that it had problems with the word-processing and printing software that printed its checks. (This defense is otherwise known as, “We wanted to pay you, but you know how these dang computers are!”)

A Costly Blip

This event wasn't exactly a cataclysmic default. The $120 million in unredeemed securities was a tiny fraction of the Treasury’s $800 billion in debt at the time. The government quickly got its act together and paid off investors—the Treasury still considers the episode to be a delay rather than a default—but Zivney’s research found that the blip had real consequences for the economy.

After the default, investors no longer saw Treasury securities as totally risk-free options, so the government suddenly had to pay a higher interest rate when it wanted to borrow money. Zivney and co-author Richard Marcus estimate that as the result of the small 1979 default, the Treasury had to up the interest rate it was paying by 0.6 percent on all of its debt. That may look like a tiny number, but when it’s spread across the Treasury’s entire debt, it adds up quickly.

It’s not clear how much we can learn about our current situation from an apparently inadvertent default over three decades ago, aside from maybe the painfully obvious point that a new default would be a very bad thing. But the next time you hear someone say a government default would be unprecedented, you’ll know better.

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July 28, 2011 - 8:14am
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