The following post comes to us from Steven L. Schwarcz
, Stanley A. Star Professor of Law & Business at Duke University School of Law.
In Rollover Risk: Ideating a U.S. Debt Default, forthcoming in the Boston College Law Review, I systematically examine 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. The impending debt-ceiling showdown between Congress and the President makes these questions especially topical. The Republican majority in Congress is conditioning any raise in the federal debt ceiling on spending cuts and reforms. Yet without raising the debt ceiling, the government may end up defaulting, perhaps as early as mid-October.
Even without that showdown, however, these questions are important. As the article explains, certain types of U.S. debt defaults, due to rollover risk, are actually quite realistic. This is the risk that the government will be temporarily unable to borrow sufficient funds to repay—sometimes termed, to refinance—its maturing debt.
Because rollover risk is such a concern, one might ask why governments, including the United States, routinely depend on borrowing new money to repay their maturing debt. The answer is cost: using short-term debt to fund long-term projects is attractive because, if managed to avoid a default, it tends to lower the cost of borrowing. The interest rate on short-term debt is usually lower than that on long-term debt because, other things being equal, it is easier to assess a borrower’s ability to repay in the short term than in the long term, and long-term debt carries greater interest-rate risk. But this cost-saving does not come free of charge: it increases the threat of default.
…continue reading: Rollover Risk: Ideating a U.S. Debt Default