For decades, investors thought the risk of the US government defaulting on its debt was essentially zero. It was nice while it lasted.
There’s still a low chance the US government will fail to pay principal or interest on nearly $30 trillion worth of Treasury securities circulating around the world. But global investors think US debt is getting riskier, and they also think US policymakers in Congress and the Trump administration are doing nothing about it.
That rising risk is likely pushing interest costs higher for every American borrowing to finance a home, a car, or a business investment.
A new paper published by the Federal Reserve Bank of Chicago uses an arcane security known as a credit default swap, or CDS, to estimate the risk of the US Treasury defaulting on a payment. The analysis highlights not just the damage caused by 15 years of political squabbling in Congress over budget issues but also the startling decline in market assessments of US creditworthiness.
Congress may soon make this worse by passing a tax-cut bill that makes America’s fiscal position even shakier.
There are two basic market concerns with America’s creditworthiness. One is the sheer amount of borrowing the US government must do to finance annual deficits that are now routinely close to $2 trillion. The total national debt is $36.2 trillion, and the amount of US debt in circulation now equals about 100% of GDP, a record for peacetime.
That’s only going higher.
The other issue is the US debt ceiling, which puts a limit on the total amount of federal borrowing the Treasury is allowed to do. The debt limit itself isn’t problematic. But Congress’s handling of it is. Three times — in 2011, 2013, and 2023 — Congress has refused to raise the borrowing limit until the Treasury Department was dangerously close to running out of money. If the Treasury missed even a single payment it owed, it would constitute a default and roil the global trillion-dollar market for Treasury securities, the world’s most widely traded assets.
In January, the Treasury hit the debt limit once again. Since then, it has been relying on “extraordinary measures” — basically, moving money around — to pay its bills. Congress must soon raise the debt limit once again, with the Treasury likely to run out of maneuvering room sometime between mid and late summer.
Credit-default swaps are private contracts that work like an insurance policy, with one party agreeing to cover losses for a second party if the issuer of a given security defaults. The market for CDS contracts on government debt has been most active during debt crises in countries such as Argentina, Brazil, Mexico, Russia, Turkey, Greece, and Italy. The market for CDSs guaranteeing US debt is often dormant. But it springs to life around the time that the US debt ceiling needs to be raised, because Congress could trigger a default by waiting too long.
The Chicago Fed research uses data on CDS pricing to estimate the market’s perception of the risk of US default going back 14 years. In 2011, the United States came within a few days of default before Democrats and Republicans sparring in Congress agreed to raise the debt ceiling. That standoff led S&P to downgrade the US credit rating for the first time ever.
The Chicago Fed paper estimates that the risk of default in 2011 peaked at more than than 6%. During debt-ceiling showdowns in 2013 and 2023, CDS pricing suggests the risk of default peaked at around 4%.
CDS pricing today suggests the risk of a US default is around 1%. It’s lower now than in prior standoffs because Republicans have unified control of Congress and don’t need to negotiate with the opposition party to raise the borrowing limit. That 1% risk could also go higher as the Treasury comes closer to the “X date” when it runs out of money.
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A 1% risk of default might seem inconsequential. But it’s not. “Everyone says the US will never default,” David Kotok, co-founder of investing firm Cumberland Advisors, told Yahoo Finance. “Somebody is saying, we don’t believe you. The CDS market is saying the risk is greater than zero.”
Kotok estimates that the higher perceived risk of default pushes the interest rate on a typical mortgage up by about three-tenths of a percentage point. That’s because investors demand higher interest rates on riskier securities, such as the 10-year Treasury note, which is the benchmark for most interest rates paid on business and consumer loans.
Read more: What is the 10-year Treasury note, and how does it affect your finances?
On a 30-year mortgage for a median-priced house, lowering the interest rate by three-tenths of a point would lower the monthly payment by about $66. That’s $792 per year or $23,769 over the course of the loan. Not a fortune, maybe, but shrewd investors welcome every marginal gain.
Congress could eliminate the debt limit altogether by repealing the 1917 law that was supposed to simplify government borrowing, rather than creating a default mechanism. Back then, the executive branch needed congressional approval for every unique instance of borrowing. The debt limit was supposed to let the Treasury borrow freely up to a certain limit. That worked more or less as intended until 2011, when Republicans, who controlled the House of Representatives, used the debt ceiling as leverage to negotiate spending cuts with Democrats, who controlled the Senate and the White House.
Repealing the debt limit might wipe out the market for credit default swaps on US debt, since debt limit deadlines are the very thing creating the default risk. Nobody would complain about that. Kotok estimates that the 30-basis-point premium on US interest rates would disappear.
Then the US government would only face one debt problem: the vast amount of it. Markets have been jeering the mushrooming national debt this year, with investors showing unprecedented reluctance to buy some US assets. That has been another factor pushing US interest rates higher, when in normal market action, they’d be holding steady or falling.
JPMorgan Chase (JPM) CEO Jamie Dimon is the latest voice of alarm on the US debt, warning that a “crack” in the bond market could signal coming market turmoil. That would most likely occur as more investors shunned US assets, including Treasurys, sending rates even higher. Treasury Secretary Scott Bessent says Dimon is overreacting, giving cover to Republicans working up the big tax-cut bill that could add another $3 trillion or $4 trillion to the national debt.
Moody’s downgraded US debt for the first time in May following Fitch’s first-ever downgrade in 2023. Like S&P in 2011, both rating agencies cited political dysfunction and huge annual deficits. The rumble of discontent with America’s fiscal recklessness is growing louder. Eventually, they’ll start to hear it in Washington, D.C.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Bluesky and X: @rickjnewman.
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