Mohamed El-Erian, chief executive officer and co-chief investment officer of Pacific Investment Management Co. (PIMCO), said there will be massive consequences if the U.S. is downgraded. El-Erain made these remarks in an interview on Bloomberg radio.
El-Erain said in the interview that PIMCO has done the hard work on an account-by-account basis to determine what they would be required to do in the event of a downgrade, and he warned that many could be "frozen in the headlights" if they haven't done the same.
There is concern that even if a resolution to the debt ceiling issue is reached, the country could still face losing its triple-A ratings. El-Erian noted in the Bloomberg telecast that a “last-minute political compromise will avoid a default but will leave the triple-A rating extremely vulnerable.”
The Government Accountability Office estimated that the general uncertainty caused by the debt ceiling debate added $78 million in additional borrowing costs to all three-month Treasury bills issued as a result of the debt limit.
A default would also mean higher interest rates which would affect funding costs for corporates and consumers and would lead to a contraction in the credit market.
"If the debt ceiling is not raised, interest rates would spike dramatically," said Tim Ryan, CEO of the Securities Industry and Financial Markets Association (SIFMA) in a note published on The Hill's Congress Blog. "Higher borrowing costs for businesses means less capital can be put toward research and development, business expansion and job creation. The prospect of paying high interest rates will force businesses to halt expansion plans, slowing their hiring because future capital will have to be dedicated to paying interest payments, instead of hiring workers. It also means that American families will face higher interest rates on car loans, home mortgages and student loans."
What will be most lamentable is that the general consensus among industry players is that a U.S. default is completely avoidable.
Ken Bentson, executive vice president of public policy and advocacy at SIFMA, pointed out in an interview on Bloomberg radio that it would be the politicians' lack of compromise, and not the inability to pay our debts, that would lead to a default.
"A downgrade would be unheard of and devastating and the biggest systemic event we could create," Bentson said. "There comes a time to use leverage and there comes a time to compromise and now is that time."