In the Event of an Official US Bankruptcy

The current known federal debt is $31.7 trillion according to the web site, US Debt Clock, which is about $94,726 for every man, woman, and child who are citizens as of April 24, 2023. Can you write a check right now made payable to the United States Treasury for the known share of the federal debt of each member of your family after liquidating the assets you own?

A report released by the St. Louis Federal Reserve Branch on March 6, 2023, stated a similar figure for the total known federal debt of about $31.4 trillion as of December 31, 2022. The federal debt size is so great, it can never be repaid in its current form.

Some of us have been in or known families or businesses who had financial debt that could not be paid, when adjustments like reducing expenses, increasing income, renegotiating loan repayments to lender(s), and selling assets to raise money for loan repayment are not enough. The reality is that they still could not pay the debt owed to the lender(s).

This leads to filing bankruptcy under federal bankruptcy laws overseen by a federal bankruptcy court.

Chapter 7 bankruptcy is a liquidation proceeding available to consumers and businesses. Those assets of a debtor that are not exempt from creditors are collected and liquidated (reduced to money), and the proceeds are distributed to creditors. A consumer debtor receives a complete discharge from debt under Chapter 7, except for certain debts that are prohibited from discharge by the Bankruptcy Code.

Chapter 11 bankruptcy provides a procedure by which an individual or a business can reorganize its debts while continuing to operate. The vast majority of Chapter 11 cases are filed by businesses. The debtor, often with participation from creditors, creates a plan of reorganization under which to repay part or all its debts.

We saw these government entities file for Chapter 9 federal bankruptcy:

Orange County, California, in 1994 for about $1.7 billionJefferson County, Alabama, in 2011 for about $5 billionThe City of Detroit, Michigan, in 2013 for about $18 billionThe Commonwealth of Puerto Rico in 2017 for $72 billion

According to the United States Courts website:

The purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.

Although similar to other chapters in some respects, chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors.

The bankruptcies of two counties, a major city, and a sovereign territory resulted in bondholders with financial losses not repaid in full as well as reforms enacted in each governmental entity. Each one emerged from bankruptcy, one hopes, humbled and better able to manage their finances.

The federal government’s best solution for bondholders, taxpayers, and other interested parties is to default, declare sovereign bankruptcy, and make the required changes to get the fiscal business in order. Default, as defined by Dictionary.com as a verb, is “to fail to meet financial obligations or to account properly for money in one’s care.”

Sovereign government defaults are not new in our lifetime with Argentina in 1989, 2001, 2014, and 2020; South Korea, Indonesia, and Thailand in 1997, known as the Asian flu; Greece in 2009; and Russia in 1998.

Some outcomes from these defaults lead to sovereign government debt bond ratings being reduced by the private rating agencies, bondholders losing value on their holdings, debt repayments being renegotiated with the bank lenders, many countries receiving loans with a repayment plan from the International Monetary Fund, reforms being required to nations’ entitlement programs, a number of government taxes being raised, their currency losing value on currency trading exchanges, price inflation becoming more of a reality to its citizens, and higher interest rates being offered on future government debt bond offerings.

Very few in the financial world are talking about the outcomes of a US federal government debt default. One outcome from the 2011 near default was Standard & Poor’s lowering their AAA federal bond rating to AA+ where it has remained.

What organization would oversee the execution of a US federal government debt default, and what authorization would they be given to deal with the situation? No suggestions are offered when its scale is numerically mind numbing since the US has used debt as its drug of choice to overdose on fiscal reality.

Some outcomes will be a lowered federal bond rating by the three private bond rating agencies, where the reality of higher interest rates being offered on newly issued federal debt cannot be ignored. Federal government spending cuts in some form will be required by the realities of economic law, which includes reducing the number of federal employees, abolishing federal agencies, reducing and reforming military budgets, selling federal government property, delegating federal programs to the states, and reforming the federal entitlement programs of Medicaid, Medicare, and Social Security. Federal government tax revenue to repay the known debt with interest will rise as a percentage of each year’s future federal budget.

One real impact from a federal government debt default would be that the US dollar would no longer be the global reserve currency, with dollars in many national reserve banks coming back to the US. Holding dollars will be like holding a hot potato. Nations holding federal debt paper—like China ($859 billion), Great Britain ($668 billion), Japan ($1.11 trillion), and others as of the January 2023 numbers published by the US Treasury—as well as many mutual funds and others will see their holdings reduced in value leading to a selling off of a magnitude one cannot imagine in scale and timing. Many mutual fund holders like retirees, city and state retirement systems, and 401(k) account holders will be impacted by this unfolding event.

The direction of an individual or business when they emerge from federal bankruptcy is hopefully humility—looking back with the perspective of mistakes made, learning from these mistakes, and moving forward with a focus to benefit their family and community.

However, cities, counties, and sovereign territories differ from individuals, families, and private businesses in emerging from federal bankruptcy. What the outcome of a federal government debt default will be is unknown. Yet its reality is before us.