Treasury bonds (T-bonds) are frequently referred to as risk-free assets by financial analysts and the financial media. And it is correct. The federal government of the United States has never defaulted on a debt or missed a payment. To lose any of the principal invested in a T-bond, you’d have to imagine the government completely collapsing.
What happens if the government defaults on its obligations?
The government will be unable to borrow extra funds to meet its obligations, including interest payments to bondholders, unless Congress suspends or raises the debt ceiling. That would very certainly result in a default.
Investors who own U.S. debt, such as pension funds and banks, may go bankrupt. Hundreds of millions of Americans and hundreds of businesses that rely on government assistance might be harmed. The value of the dollar may plummet, and the US economy would almost certainly slip back into recession.
And that’s only the beginning. The dollar’s unique status as the world’s primary “unit of account,” implying that it is widely used in global finance and trade, could be jeopardized. Americans would be unable to sustain their current standard of living without this position.
A US default would trigger a chain of events, including a sinking dollar and rising inflation, that, in my opinion, would lead to the dollar’s demise as a global unit of account.
All of this would make it far more difficult for the United States to afford all of the goods it buys from other countries, lowering Americans’ living standards.
Are US Treasury bonds at risk of default?
If you’ve ever loaned money to someone, you’ve probably considered the likelihood of repayment. Some loans carry a higher risk than others. When it comes to bonds, the same is true. You’re betting that the issuer will keep its pledge to repay principle and pay interest on the agreed-upon dates and terms.
While U.S. Treasury assets are typically considered to be risk-free, most bonds are susceptible to default. This means the bond obligor will either be late paying creditors (including you, as a bondholder), pay a reduced amount, or, in the worst-case scenario, be unable to pay at all.
Is it possible to lose money by investing in US Treasury bonds?
Yes, selling a bond before its maturity date can result in a loss because the selling price may be lower than the buying price. Furthermore, if a bondholder purchases a corporate bond and the firm experiences financial difficulties, the company may not be able to repay all or part of the initial investment to bondholders. When investors purchase bonds from companies that are not financially solid or have little to no financial history, the chance of default increases. Although these bonds may have higher yields, investors should be mindful that higher yields usually imply greater risk, since investors expect a bigger return to compensate for the increased chance of default.
Are US government bonds safe?
Treasury securities (“Treasuries”) are issued by the federal government and are considered to be among the safest investments available since they are guaranteed by the US government’s “full faith and credit.” This means that no matter what happensrecession, inflation, or warthe US government will protect its bondholders.
Treasuries are a liquid asset as well. Every time there is an auction, a group of more than 20 main dealers is required to buy substantial quantities of Treasuries and be ready to trade them in the secondary market.
There are other characteristics of Treasuries that appeal to individual investors. They are available in $100 denominations, making them inexpensive, and the purchasing process is simple. Treasury bonds can be purchased through brokerage firms and banks, or by following the instructions on the TreasuryDirect website.
Can the United States fail on its debt?
The United States has never defaulted on its debt in contemporary history. The government has a self-imposed borrowing limit known as the debt ceiling, which it has raised or suspended over time in order to keep the United States from defaulting on its obligations.
Is it true that the US has never defaulted on its debt?
The United States’ credit is based on centuries of stability and accountability. Because of the debt ceiling, this country has never purposefully defaulted on its debts. However, unless Congress lifts or suspends the debt ceiling by October 18th, the US Treasury Department predicts that it will have very little resources to avoid doing so for the first time. If Congress does not act, the United States may take decades to properly recover.
A default would severely limit the federal government’s ability to serve the American people. Families’ reliance on federal government payments to make ends meet would be jeopardized. The federal government’s core duties, such as national defense, national parks, and countless others, would be jeopardized. The public health system, which has allowed this country to respond to a global pandemic in the past, would be unable to cope.
A default would also have substantial and long-term financial and economic consequences. The currency would weaken, and stocks would plummet as financial markets lost faith in the US. The United States’ credit rating would almost probably be reduced, and many consumer loan interest rates would rise, making items like auto loans and mortgages more expensive for families who are exposed to interest rate adjustments or who are taking out new loans. These and other repercussions might lead to a recession and a credit market freeze, limiting American businesses’ capacity to operate.
We explain what the debt limit is in a companion blog article. We go much further in this essay, outlining the dangers that Americans and the USand globaleconomy will face in the days, months, and years following a default.
The federal government’s ability to carry out essential functions, such as providing financial aid to tens of millions of Americans, would be severely hampered.
The consequences of a default would be felt by everyone in the United States. If the US defaults, tens of millions of people, especially families with children, seniors, and veterans, would face the risk of losing regular Federal payments that help them make ends meet swiftly, even overnight in some situations.
In 2020, about 50 million citizens will receive Social Security retirement benefits, with another 6 million receiving survivors benefits. Around 12 million people rely on Social Security as their primary source of income in 2015. The average retired Social Security beneficiary expects to receive over $1,600 per month, as indicated in Figure 1. On average, Social Security benefits account for more than half of household income among households receiving benefits. Nonetheless, if we default, these Americans may not receive their Social Security benefits on time, if at all.
During a pandemic, health coverage would also be in jeopardy. Medicare covers roughly 60 million individuals in the United States, Medicaid covers 75 million, and the Children’s Health Insurance Program covers nearly 7 million children (CHIP). Each beneficiary receives around $1,100 in net Medicare payments. Although inexpensive health care is critical, especially in the event of a pandemic, millions of people may be left without coverage.
A default would also jeopardize veterans’ programs, as over 9 million veterans rely on physical and mental health care, as well as other services. The average monthly disability payout for a single veteran with a 50% disability rating and no dependents is roughly $900; veterans with families or higher disability ratings earn more.
Millions of people would be unable to put food on the table or pay their rent if the federal government missed or delayed payments. The early hardships faced by families going hungry and standing in food lines, before the full weight of the Federal pandemic response had come to bear, remind us of the visceral pain that inadequate Federal help delivers in the aftermath of an economic shock.
The table below lists some of the other key sources of federal assistance that could be jeopardized. Of course, this is an underrepresentation, as the federal government funds a wide range of programs that Americans rely on, from childcare to financial assistance to assistance for small business owners.
Furthermore, many people benefit from multiple federal programs at the same time. Consider the impact on three typical American families: an elderly couple, a single veteran, and a young family with two children if the federal government fails to meet its commitments. In a variety of ways, they all profit from the federal government. As seen in the chart below, a typical married senior couple receives more than $4,800 a month from Social Security and Medicare alone, not to mention any other benefits they may be eligible for.
- At the age of 35, a crippled veteran getting special monthly compensation finishes college.
- $40/month for a Special Supplemental Nutrition Program for Women, Infants, and Children
The ability of the federal government to provide for national defense, pandemic response, and day-to-day services would almost certainly be severely impaired.
Many other services of the federal government that we typically take for granted would be jeopardized if the country defaulted. The federal government, for example, ensures the safety of our country by paying the salaries of 1.4 million active duty military soldiers and their families. After a default, personnel deployment, equipment maintenance, supply procurement, and other support activities could be halted, hampereding the country’s defense at a time when there are numerous threats to national security. The same may be said for counter-terrorism and intelligence expenditures, which may make America more exposed to possible threats.
The Federal health response to COVID necessitates inspections and certification of pharmaceuticals that might be halted without financing, such as vaccine and therapeutic approvals through the FDA, which is currently underway for the COVID vaccine for American children. Other vital day-to-day functions, including as the functioning of our national parks, postal delivery, consular services in other countries (which support American people overseas), and air traffic controlwhich may potentially ground passenger and freight planeswould also be jeopardized.
There are also services that rely on federal funding, which many Americans are likely unaware of. In the event of a default, the National Meteorological Service, for example, may have difficulty communicating critical weather information to families, local news stations, and businesses. Because the Federal Communications Commission organizes the radio telecommunication system, the ability to listen to and converse via radio would be jeopardized. The National Institute of Standards and Technology also keeps track of the official time in the United States, which is important for computers and travel because GPS systems rely on precise official clocks.
A default has far-reaching consequences that go beyond the lack of financial aid to individuals in need. Everyday services that are essential to a functional societymany of which appear to operate in the background of our liveswould be jeopardized. Failure to pay for these services would cause significant disruptions across the country.
Even the fear of a default, let alone an actual default, would harm markets and consumers.
Finally, a defaultor even the fear of a defaultwould be disastrous for our economy.
Market risk measures grew steadily in the run-up to and following the 2011 debt limit crisis, when the government narrowly avoided defaulting, while consumer confidence and small-business optimism dropped. After that year’s debt limit crisis resolved, mortgage rates jumped by 0.7 to 0.8 percentage point for two months before progressively declining. An extra 0.8 percentage point represents more than $30,000 in additional interest payments over the life of a $250,000 30-year fixed-rate mortgage for a family. In the aftermath of the 2011 financial crisis, interest rates on auto loans, personal loans, and other consumer financial goods increased, and these hikes often lingered for months. This happened despite the fact that Congress acted quickly to avoid a default, before the US Treasury ran out of cash and other options for financing.
While previous experiences can assist us predict what to expect if the federal government fails to uphold its duties, they are likely to underestimate the consequences. Even if rapidly handled, a true default would almost certainly have far more pronounced consequences and financial damage.
If not resolved, the implications of a default might escalate quickly, resulting in a global financial crisis and recession.
If the United States defaults, the implications might be severe. Because the United States has never defaulted, the timing of these consequences is unknown; also, the consequences of a default would not be limited to the United States. The world economy, which is dependent on a healthy US economy, would enter a financial crisis and, most likely, a recession. Treasury debt is the world’s safest asset, and its interest rates are used to price a wide range of financial goods and transactions all around the world. The United States dollar is also the world’s most valuable reserve currency. A default would send shockwaves through global financial markets, causing credit markets to freeze up around the world and stock markets to plummet. Employers all throughout the world would very certainly have to start laying off employees. The global financial crisis of 2008 had knock-on repercussions in the United States, prompting businesses to lay off people and reduce private investment. In addition to damaging a global economy still recovering from the epidemic, a financial crisis triggered by a default has the potential to be considerably worse.
Previous simulations by the Federal Reserve and the Peterson Foundation, which looked at the possibility of a month-long default in 2013, predicted that unemployment would rise and stay high for at least two to four years. According to Moody’s, a prolonged 4-month default would result in a 4% drop in real GDP, a nearly 9% increase in unemployment, and the loss of over 6 million jobs in the US economy. To put things in perspective, real GDP decreased by 4.3 percent during the Great Recession, unemployment climbed to 10%, and the economy lost nearly 9 million jobs.
The fact that the federal government would be frozen in reacting to the very economic catastrophe that a default would undoubtedly cause adds to the severity of a default. It would most certainly be unable to provide the type of assistance that was so important to families during previous economic downturns and, more recently, during the coronavirus pandemic. Instead, the federal government could only watch helplessly as the economy spiraled out of control.
In short, the US has never purposefully defaulted on its debts for one reason above all others: the self-inflicted economic catastrophe that would result from doing so would be disastrous. Even the possibility of a default has severe consequences for the US economy, and a full-fledged default for any length of time would be a devastating blow to people, businesses, and the economy in the United States and around the world for decades. The debt ceiling is not a political football, and it should not be treated as one. The ramifications are far too severe.
Maintenance of the electricity grid through the Federal Energy Regulatory Commission (FERC) would be jeopardized in the case of a default, according to an earlier version of this blog entry. While the Federal Energy Regulatory Commission (FERC) is responsible for enforcing reliability standards for the bulk electricity system, it is not responsible for running the grid.
Why are government bonds thought to be almost risk-free?
A risk-free asset is one with a guaranteed future return and almost little chance of loss. Because the US government backs them with its “full confidence and credit,” debt obligations issued by the US Treasury (bonds, notes, and especially Treasury bills) are considered risk-free. The return on risk-free assets is very close to the present interest rate because they are so safe.
Why aren’t US Treasury bonds entirely risk-free?
Why aren’t US Treasury bonds entirely risk-free? The value of the currency may depreciate in relation to the dollar, resulting in the bond holder receiving fewer dollars. Floating rate bonds, zero coupon bonds, callable bonds, putable bonds, income bonds, convertible bonds, and inflation-indexed bonds are all terms used to describe different types of bonds.
Are municipal bonds safe from default?
- Municipal bonds are a wonderful option for consumers who want to keep their money while earning tax-free income.
- General obligation bonds are used to quickly raise funds to meet expenses, whereas revenue bonds are used to fund infrastructure projects.
- Both general obligation and revenue bonds are tax-free and low-risk investments, with issuers who are quite likely to repay their loans.
- Municipal bonds are low-risk investments, but they are not risk-free because the issuer may fail to make agreed-upon interest payments or be unable to repay the principal at maturity.
Are bonds secure at the moment?
“The I bond is a fantastic choice for inflation protection because you receive a fixed rate plus an inflation rate added to it every six months,” explains McKayla Braden, a former senior counselor for the Department of the Treasury, referring to a twice-yearly inflation premium.
Why invest: The Series I bond’s payment is adjusted semi-annually based on the rate of inflation. The bond is paying a high yield due to the strong inflation expected in 2021. If inflation rises, this will also adjust higher. As a result, the bond protects your investment from the effects of rising prices.
Savings bonds are regarded one of the safest investments because they are backed by the United States government. However, keep in mind that if and when inflation falls, the bond’s interest payout would decrease.
A penalty equal to the final three months’ interest is charged if a US savings bond is redeemed before five years.
Short-term certificates of deposit
Unless you take the money out early, bank CDs are always loss-proof in an FDIC-backed account. You should search around online and compare what banks have to offer to discover the best rates. With interest rates expected to climb in 2022, owning short-term CDs and then reinvesting when rates rise may make sense. You’ll want to stay away from below-market CDs for as long as possible.
A no-penalty CD is an alternative to a short-term CD that allows you to avoid the normal penalty for early withdrawal. As a result, you can withdraw your funds and subsequently transfer them to a higher-paying CD without incurring any fees.
Why should you invest? If you keep the CD until the end of the term, the bank agrees to pay you a fixed rate of interest for the duration of the term.
Some savings accounts provide higher interest rates than CDs, but these so-called high-yield accounts may need a substantial deposit.
Risk: If you take money out of a CD too soon, you’ll lose some of the interest you’ve earned. Some banks will also charge you a fee if you lose a portion of your principle, so study the restrictions and compare rates before you buy a CD. Furthermore, if you lock in a longer-term CD and interest rates rise, you’ll receive a smaller yield. You’ll need to cancel the CD to get a market rate, and you’ll likely have to pay a penalty.
Money market funds
Money market funds are pools of CDs, short-term bonds, and other low-risk investments that are sold by brokerage firms and mutual fund companies to diversify risk.
Why invest: Unlike a CD, a money market fund is liquid, which means you can usually withdraw your funds without penalty at any time.
Risk: Money market funds, according to Ben Wacek, founder and financial adviser of Guide Financial Planning in Minneapolis, are usually pretty safe.
“The bank informs you what rate you’ll earn, and the idea is to keep the value per share over $1,” he explains.
Treasury bills, notes, bonds and TIPS
Treasury bills, Treasury notes, Treasury bonds, and Treasury inflation-protected securities, or TIPS, are all issued by the US Treasury.
- TIPS are investments whose principal value fluctuates with the direction of inflation.
Why invest: All of these securities are very liquid and can be purchased and sold directly or through mutual funds.
Risk: Unless you buy a negative-yielding bond, you will not lose money if you hold Treasurys until they mature. If you sell them before they mature, you risk losing some of your principle because the value fluctuates with interest rates. Interest rates rise, which lowers the value of existing bonds, and vice versa.
Corporate bonds
Corporations can also issue bonds, which range from low-risk (issued by large profitable enterprises) to high-risk (issued by smaller, less successful companies). High-yield bonds, also known as “junk bonds,” are the lowest of the low.
“There are low-rate, low-quality high-yield corporate bonds,” explains Cheryl Krueger of Growing Fortunes Financial Partners in Schaumburg, Illinois. “I think those are riskier because you’re dealing with not only interest rate risk, but also default risk.”
- Interest-rate risk: As interest rates change, the market value of a bond might fluctuate. Bond values rise when interest rates decrease and fall when interest rates rise.
- Default risk: The corporation could fail to fulfill the interest and principal payments it promised, ultimately leaving you with nothing on your investment.
Why invest: Investors can choose bonds that mature in the next several years to reduce interest rate risk. Longer-term bonds are more susceptible to interest rate movements. Investing in high-quality bonds from reputed multinational corporations or buying funds that invest in a broad portfolio of these bonds can help reduce default risk.
Bonds are often regarded to be less risky than stocks, but neither asset class is without risk.
“Bondholders are higher on the pecking order than stockholders,” Wacek explains, “so if the company goes bankrupt, bondholders get their money back before stockholders.”
Dividend-paying stocks
Stocks aren’t as safe as cash, savings accounts, or government bonds, but they’re safer than high-risk investments like options and futures. Dividend companies are thought to be safer than high-growth equities since they provide cash dividends, reducing but not eliminating volatility. As a result, dividend stocks will fluctuate with the market, but when the market is down, they may not fall as much.
Why invest: Dividend-paying stocks are thought to be less risky than those that don’t.
“I wouldn’t call a dividend-paying stock a low-risk investment,” Wacek says, “since there were dividend-paying stocks that lost 20% or 30% in 2008.” “However, it has a smaller risk than a growth stock.”
This is because dividend-paying companies are more stable and mature, and they provide both a payout and the potential for stock price increase.
“You’re not just relying on the stock’s value, which might change, but you’re also getting paid a regular income from that stock,” Wacek explains.
Danger: One risk for dividend stocks is that if the firm runs into financial difficulties and declares a loss, it will be forced to reduce or abolish its dividend, lowering the stock price.
Preferred stocks
Preferred equities have a lower credit rating than regular stocks. Even so, if the market collapses or interest rates rise, their prices may change dramatically.
Why invest: Preferred stock pays a regular cash dividend, similar to a bond. Companies that issue preferred stock, on the other hand, may be entitled to suspend the dividend in particular circumstances, albeit they must normally make up any missing payments. In addition, before dividends may be paid to common stockholders, the corporation must pay preferred stock distributions.
Preferred stock is a riskier variant of a bond than a stock, but it is normally safer. Preferred stock holders are paid out after bondholders but before stockholders, earning them the moniker “hybrid securities.” Preferred stocks, like other equities, are traded on a stock exchange and must be thoroughly researched before being purchased.
Money market accounts
A money market account resembles a savings account in appearance and features many of the same features, such as a debit card and interest payments. A money market account, on the other hand, may have a greater minimum deposit than a savings account.
Why invest: Money market account rates may be greater than savings account rates. You’ll also have the freedom to spend the money if you need it, though the money market account, like a savings account, may have a monthly withdrawal limit. You’ll want to look for the greatest prices here to make sure you’re getting the most out of your money.
Risk: Money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC), which provides guarantees of up to $250,000 per depositor per bank. As a result, money market accounts do not put your money at risk. The penalty of having too much money in your account and not generating enough interest to keep up with inflation is perhaps the most significant danger, since you may lose purchasing power over time.
Fixed annuities
An annuity is a contract, usually negotiated with an insurance company, that promises to pay a set amount of money over a set period of time in exchange for a lump sum payment. The annuity can be structured in a variety of ways, such as paying over a certain amount of time, such as 20 years, or until the client’s death.
A fixed annuity is a contract that promises to pay a set amount of money over a set period of time, usually monthly. You can contribute a lump sum and start receiving payments right away, or you can pay into it over time and have the annuity start paying out at a later date (such as your retirement date.)
Why should you invest? A fixed annuity can provide you with a guaranteed income and return, which can help you feel more secure financially, especially if you are no longer working. An annuity can help you build your income while avoiding taxes, and you can contribute an unrestricted amount to the account. Depending on the contract, annuities may also include a variety of extra benefits, such as death benefits or minimum guaranteed payouts.
Risk: Annuity contracts are notoriously complicated, and if you don’t read the fine print carefully, you could not get precisely what you expect. Because annuities are illiquid, it might be difficult or impossible to break out of one without paying a hefty penalty. If inflation rises significantly in the future, your guaranteed payout may become less appealing.
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Before making an investment choice, all investors are urged to perform their own independent research into investment techniques. Furthermore, investors should be aware that historical performance of investment products does not guarantee future price appreciation.