- Financial Services
- Retirement Security
Impact of a Default on Financial Stability and Economic Growth
Oral Statement of Paul Schott Stevens
President and CEO
Investment Company Institute
Senate Committee on Banking, Housing, and Urban Affairs
October 10, 2013
As prepared for delivery.
I’m pleased to testify on behalf of the Investment Company Institute, its member funds, and the 90 million American investors they serve. Members of ICI manage more than $15 trillion total assets.
Funds and their investors have a significant stake in the stability and predictability of the market for U.S. Treasury securities. The most recent ICI data show that as of June 30, registered funds held more than $1.7 trillion in securities issued by the Treasury and U.S. government agencies—accounting for more than 10 percent of their assets.
U.S. Treasuries trade in the deepest, most liquid market in the world. Treasury securities have always been regarded as providing the “risk-free rate of return,” a key factor in pricing other assets, including corporate and municipal bonds, stocks, and real estate.
But today, that notion of the “risk-free rate” is in serious jeopardy.
Today, Washington—the federal government—is itself the single greatest source of risk to the global financial system.
The immediate threat to financial stability is, of course, the looming stalemate over the federal debt ceiling. But we must not lose sight of the longer-term hazards our nation faces if we fail to take decisive action to contain the growth of our national debt.
After all, there are two things that individuals, households, businesses, or nations must do to maintain a high level of creditworthiness:
- They must pay their bills on time, when they come due; and
- They must avoid taking on more debt than they can reasonably afford to service and repay.
For our nation, ignoring either of these principles will be ruinous. A Treasury default likely precipitates a sudden crisis and degradation of the United States’ financial and economic standing. But failure to bring our debt under control will be equally destructive and, on current trends, is even more likely.
What makes the Treasury market so deep and so liquid is the certainty of investors that the U.S. Treasury will pay its obligations, on time and in full, when interest or principal comes due.
Once Treasury misses or delays a payment, investors will learn a lesson that cannot be unlearned: Treasury securities are no longer as good as cash. The future risk of missed payments will be priced into the interest rates that investors demand.
We already can see early signs of these concerns developing in the market, as the October 17 deadline approaches. And should the Treasury default, the effects would quickly spill beyond the Treasury markets and into the broader economy. Multiple shocks—cash shortfalls for holders of defaulted Treasuries, higher interest rates, diminished confidence, and pressure on the dollar—would be likely to undermine economic activity. The impact would persist well beyond any resolution of the debt ceiling and repair of defaults.
Let me stress that default is by no means uniquely a problem for mutual funds or other registered investment companies. Nothing about their structure makes them any more vulnerable than any other investment vehicle. Because the health of the Treasury market underpins virtually all financial markets, the damage of a default—or even of a second near-miss in a little over two years’ time—will be visited upon every American who saves, invests, borrows, or has any stake in the economy.
With our focus on the debt ceiling, it’s easy to lose sight of the other looming risk—the unsustainable long-term growth in our national debt.
The tax and spending bargains reached so painfully in the past three years have slowed the growth of debt for the short term. But the Congressional Budget Office’s latest projections show that that progress will be short-lived.
By 2018, the debt held by the public will be rising again as a share of GDP. By 2038, under current law and budgetary policies, federal debt held by the public will reach 108 percent of GDP.
CBO also offers an alternative forecast with budgetary assumptions that are probably more realistic than the baseline. In that alternative, the debt will be nearly twice the size of our economy—190 percent of GDP—by 2038.
Neither of these scenarios promises a bright future for the economy or nation. High levels of debt are associated with slower rates of economic growth. And our economy will become increasingly vulnerable to fiscal crises should our creditors—including foreign investors—lose confidence in our ability or willingness to service our mounting debt.
So I have two unequivocal messages today.
First, no one should take lightly the prospect of a default on the United States’ debt obligations. The credit of the United States emphatically must not be put into question.
Second, those who dismiss or minimize our current budget problems also are playing with fire. The risks they are taking may be less immediate, but they are no less consequential—and the longer our nation delays action, the larger and more difficult the necessary corrective steps become.
Thank you and I look forward to your questions.