How to protect yourself from a U.S. default

July 14, 2011

Can you protect yourself from a U.S. debt default?

The short answer: Probably not.

But that hasn’t stopped Bob Goldman’s clients from calling, seeking advice on what to do now. Goldman, an hourly financial planner in Sausalito, California, says his phones starting ringing on Tuesday with calls from clients worried about a government default. “It’s finally built up. All the bad news and the scary stuff has reached a point where we can’t deal with it anymore. Sometimes there’s no more room for anyone else under the bed,” he says.

Let’s review what a U.S. government default would mean for consumers. First and foremost, the United States could lose its top-notch AAA credit rating if lawmakers fail to increase the country’s legal borrowing limit and the government misses debt payments. While a default would roil global markets, a lower credit rating would have a lingering ripple effect for consumers. It would increase borrowing costs for everything, including cars, mortgages and credit cards.

Credit guru Greg McBride at Bankrate.com, sees a rapid re-pricing — “in a downward direction” — of all financial assets, not just Treasury debt. Why? Government debt is considered risk-free. America’s “risk-free rate” is fundamental to the pricing of all financial assets, like stocks and bonds, McBride explains:

Recall the mayhem of 2008 when asset prices plunged as panic spread.

But this time, there would be no place to hide. In 2008, nervous investors fled to the safety of U.S. Treasury securities. As an asset class, they performed well as a result. But in the event of default, this safe haven would no longer be a safe haven. The unthinkable would likely soon happen: America would see its enviably unblemished credit rating cut.

Any cut in the U.S. credit rating would cause a stampede out of Treasuries. That would produce a domino effect, with 401(k)s, IRAs and college savings accounts plunging in value as the holdings they’re invested in melted down. Faced with a sell-at-any-price panic mode, even some pensions could have trouble meeting their obligations due to rapidly falling asset prices.

Next, we’d quickly have a renewed credit crunch on our hands. The new market mantra would be, “If the U.S. can default, anybody can.” No one would want to lend to anyone. The flow of credit would come to a screeching halt. A run on money market funds could begin. Only this time there wouldn’t be a government backstop, like the one erected in 2008 to calm fearful markets.

As investors abandoned Treasuries, the prices would plunge. So yields — which move inversely to price — would bolt upward. And that is where consumers of every stripe would take a hit. They would see higher rates for mortgages and consumer loans. Furthermore, credit lines would be frozen or cut for businesses and consumers. Companies would shed workers in a bid to conserve cash, producing a rapid economic deceleration much like the fall of 2008.

This certainly doesn’t sound pretty — which is why many people doubt that a default will actually happen on D-Day (Aug. 2).  Goldman compares this unusual situation “to something that’s become sickeningly common” — a mortgage default: “The country defaults, and if we’re lucky, we do a short sale on the country. Most likely, we’ll have to foreclose the United States, and put the country up for auction. Perhaps China would be interested in making a bid. Or Switzerland. Canada, definitely. Then, all 300 million of us become renters! We keep living here and pay rent! Pretty neat.”

Gallows humor aside, Goldman says the current situation is “truly scary, and bad for every kind of investment.” Even so, he’s telling clients to stay put in their portfolios. “Leave it alone, unless something changes in (your) life. Not if something changes in the country or the politics,” he advises.

Chip Workman, lead adviser at the Asset Advisory Group in Cincinnati, Ohio, says a default is highly unlikely, “even in the face of all the political gaming currently going on in Washington.” And that’s why he is sticking with stocks. “In the long run, companies large and small, both in the U.S. and abroad will continue to reward their investors with fair returns for the risk being taken.”

Admittedly, it’s tough to manage investing behavior and maintain discipline in uncertain moments like this, but asset allocation, rebalancing, buying on the dips, and knowing your risk tolerance “still remains the ultimate long-term defense against the unknown,” Workman says.

Of course, the sit-tight, buy-and-hold approach doesn’t work for everyone. With the August 2 deadline for the debt ceiling looming, we’ll examine other options for consumers in future posts.

11 comments

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You would think that people would wise up and see the GOP tactics for what they are: make Obama fail regardless of the cost to anyone else. If everyone’s 401K melts down again, for the second time in 5 years, the GOP will either splinter into two parties or disappear altogether. Frankly, I think we need a responsible alternative to the Democratic party, but right now, the GOP doesn’t fit that description.

Posted by Quatermass | Report as abusive

No thanks. I’ll do what I did in 2008 – get out before the stampede starts and buy back in when it bottoms.

Posted by Pete_Murphy | Report as abusive

This piece was doing relatively well for a MSM piece, right up until Ms. Young permitted the advisors she interviewed to posit advice, without any critique, contrary view of analysis. And the advice given is horrible. It reflects a lack of understanding of the new dynamics. This isn’t a repeat of the conditions of 2008. This is a CONTINUATION of the conditions of 2008.

Follow Mr. Goldman’s advice, and you’ll be wondering where the heck your 401(k) went by the end of this year.

Posted by BowMtnSpirit | Report as abusive

don’t mention gold, don’t mention gold, don’t mention gold…

Posted by reconstructions | Report as abusive

Ive been earning my income in RMB for the past year and have chosen not to exchange anything to dollars for this exact reason. Once again politicians have chosen to themselves ahead of their country.

Posted by kc10man | Report as abusive

What a lot of nonsense the politicians are putting us through. A sad commentary on how supposedly grown men and women cannot do what is best for the country ahead of what is best for them. I am truly sick of it, but I have basically no voice in the Senate, my Senators being of the other party. Whenever I try to voice my concerns I am basically told that my views are wrong and that the Senator will continue to do just what he pleases.

But the truth is, that the US is cooking the books and has been for at least the past decade. These ridiculously inflated housing prices have screwed up the economy, and it isn’t even close to being fixed yet. Maybe default is the only answer. We aren’t creating enough employment opportunities for people to afford housing at the current prices, which then depletes the state and local governments whose tax income relies on home ownership. Now would be an excellent time to immediately institute a consumption tax to raise revenues. Cutting at this point means peoples jobs, which means further loss of tax revenues.

Posted by lhathaway | Report as abusive

[…] this is not the time to turn a farce into a tragedy. A default on U.S. debt will make the 2008 debacle look like a Simpson’s episode. Interest rates will soar through […]

Posted by Debt ceiling & dumber: No safe haven for your money? | Reuters Wealth | Report as abusive

Don’t mention gold, and don’t mention silver.

Posted by rhess595 | Report as abusive

[…] this is not the time to turn a farce into a tragedy. A default on U.S. debt will make the 2008 debacle look like a Simpson’s episode. Interest rates will soar through […]

Posted by John Wasik | Analysis & Opinion | Reuters.com | Report as abusive

gold….silver….he

Posted by kc10man | Report as abusive

It’s all baloney! Why?? Because in the real world, the USA couldn’t possible hold a AAA credit rating at This point! We are BROKE. Flat out.

When, and IF, at some time in the future, we have enough people in high places who actually give a damn about doing what NEEDS to be done — we’ll cut the govt payroll by 75%, cut the handouts by 50%, close the freaking borders, and get the hell out of countries in which we have no business.

We’ll take care of our own first — and then take care of others who actually appreciate what we do for them IF WE CAN.

dock j

Posted by dockj | Report as abusive

[…] let’s look at the possibility that the United States could be in default if debt ceilings don’t rise. OK, that’s a big if. And let’s not dismiss those other meltdown […]

Posted by Bipolar investing: Understanding the rush to cash | Reuters Money | Report as abusive

[…] let’s look at the possibility that the United States could be in default if debt ceilings don’t rise. OK, that’s a big if. And let’s not dismiss those other meltdown […]

Posted by Bipolar investing: Understanding the rush to cash | Bipolar Teen Blog | Report as abusive

I would urge those that would not consider precious metal ie. gold/silver to reconsider. It truly is the only investment that will preserve wealth. It is the only ‘currency’ that can keep up to inflation. If you don’t think we have inflation…I beg to differ. Do your own research, look into precious metals and how they have been used in preserving wealth. Imagine if every American dollar was back up with 1 oz of silver…as it once was, and not too long ago. You couldn’t print money and a dollar would be worth a dollar. Our currency is being eroded. Precious metal, although some would say are being manipulate and suppressed are still really the only option. If you think they are at high valuations now………………………………………..hold on to your seat!!!!!! You haven’t seen anything, anything, anything yet!

Posted by Bluepill | Report as abusive

I would urge those that would not consider precious metal ie. gold/silver to reconsider. It truly is the only investment that will preserve wealth. It is the only ‘currency’ that can keep up to inflation. If you don’t think we have inflation…I beg to differ. Do your own research, look into precious metals and how they have been used in preserving wealth. Imagine if every American dollar was back up with 1 oz of silver…as it once was, and not too long ago. You couldn’t print money and a dollar would be worth a dollar. Our currency is being eroded. Precious metal, although some would say are being manipulate and suppressed are still really the only option. If you think they are at high valuations now………………………………………..hold on to your seat!!!!!! You haven’t seen anything, anything, anything yet!

Posted by Bluepill | Report as abusive