That would cause another financial crisis. It would be like the financial crisis of 2008, only scarier, because it's unprecedented.
The Treasury Department says it will run out of money to pay its bills by mid-October. If Congress doesn't raise the government's debt ceiling and let it borrow more to pay old bills, then the U.S. government could default on its debts for the first time in history.
"Crossing the debt ceiling would be catastrophic," RBC Capital Markets analysts said in a research note.
Cardiff Garcia of FT Alphaville and Kevin Roose of New York magazine have longer, more detailed, explanations of why this is so. For people like me with wrecked attention spans, here is the short version:
- The repo market, where banks borrow short-term cash using Treasury debt as collateral, could freeze up. This means the entire credit market freezes up.
- Fedwire, a clearinghouse for banks to shuttle money and bonds and stuff back and forth to each other, could also freeze up. This means possible widespread bank failures.
- The Fed's emergency borrowing window for banks might shut down, because the Fed can't accept defaulted Treasury debt as collateral. That cuts off a lifeline for banks.
- Money market funds, which invest in short-term Treasury debt on behalf of millions of investors, could fail. This means big losses for individuals and could worsen the panic in short-term debt markets.
- The commercial paper market, where companies borrow short-term cash to cover payroll and bills, could freeze up when money-market funds get into trouble.
- Stock, bond and other financial markets could panic in advance of a debt-ceiling breach, or immediately afterward. This means more big losses for individuals and longer-term economic damage.