Rollover Risk: Ideating a U.S. Debt Default

Abstract

This article examines how a U.S. debt default might occur, how it could be avoided, its potential consequences if not avoided, and how those consequences could be mitigated. To that end, the article differentiates defaults caused by insolvency from defaults caused by illiquidity. The latter, which are potentiated by rollover risk (the risk that the government will be temporarily unable to borrow sufficient funds to repay its maturing debt), are not only plausible but have occurred in the past. Moreover, the ongoing controversy over the federal debt ceiling and the rise of the shadow-banking system make these types of defaults even more likely today. The article also examines how a U.S. debt default could be avoided, discussing steps — including monetizing debt and printing money to pay maturing debt — that the government could take to facilitate debt repayment, as well as limits on the government’s ability to avoid defaulting. The article then examines the consequences of a U.S. debt default, demonstrating that even a temporary default caused by illiquidity would have severe economic and systemic consequences, significantly raising the cost of borrowing and causing securities markets to plummet. Such a default would also raise a host of legal issues, including constitutional questions of first impression under the Fourteenth Amendment. Finally, the article explores how the negative consequences of a default might be mitigated, potentially through a debt restructuring or even a possible IMF bailout.