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As Debt Limit Deadline Draws Closer, We (Sadly) Explain What ‘Default’ Could Mean

Alas, we’d hoped it wouldn’t come to this point.

But seeing as the United States is now just days away from the August 2 deadline for raising the debt limit, we figured it was time for an explainer on what it could mean if Congress fails to solve its budget stalemate. (See our continually updated reading list.)

First, let’s review what this scary word, “default,” actually means. It’s essentially failure to honor the debt that’s owed. And in a very general sense, that’s what will happen after—or not long after—the August 2 deadline passes.

But to be more specific, the United States actually has two main types of “debt”: 1) the debt to investors who bought U.S. bonds, meaning they loaned money to the U.S. government, and 2) bills that come due, such as payments owed to Social Security, Medicare, pension plans, contractors etc. Defaulting on bonds—that is, not paying back a loan—will have more far-reaching consequences on interest rates, credit ratings, and on the global markets than missing payments for spending. (Of course, if you're one of the millions of Americans who depend on Social Security, any suspension of those checks will be plenty serious as well.) 

After August 2, the government will still have some incoming revenue to pay some debts, but it won't have enough to cover everything. (Check out this neat interactive from Bloomberg Government to see the situation up close.) 

It's still unclear exactly which obligations will get covered and which won't, but the likelihood that bondholders will go unpaid is extremely low. Or nil, as Slate puts it. One anonymous administration official told Bloomberg that bondholders will be prioritized. 

The White House said this week that in the next few days, the administration will reveal its repayment priorities. Perhaps wary of the PR implications of putting investors first in line, Treasury officials have suggested the United States doesn’t have the authority to prioritize certain payments over others. The Government Accountability Office looked into the matter and reached a different conclusion—that “Treasury is free to liquidate obligations in any order it finds will best serve the interests of the United States.” (This handy Congressional Research Service report [PDF] has more details.) 

Assuming the United States does prioritize investors, Social Security recipients may not be the only ones who could be left empty-handed until the mess is sorted out. Government contractors could be in this group, and they’re bracing for it. The troops could have their paychecks put on hold. Veterans payments could be stopped. Revenue going from the federal government to the states for construction, Medicaid and unemployment would also likely be stopped.

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