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Yellen correct in saying default as an option ‘is catastrophic’: Economist

Joe Brusuelas, RSM Chief Economist joins the Yahoo Finance Live panel to recap the Senate Banking Committee oversight hearing on pandemic recovery funds.

Video transcript

- And, Joe, appreciate you taking the time. Obviously, a lot of different topics there. But I just want to kind of lean into what we're seeing play out here in the markets just given kind of the inflation moving forward, what we're seeing on the 10-year, driving down some of those tech stocks. I mean, what did you make of what you heard in that testimony and I guess kind of what we're seeing play out in the markets today?

JOE BRUSUELAS: Well, I think the big news in the testimony was actually prior to the testimony in Secretary Treasury Yellen's letter to Speaker of the House Nancy Pelosi where she announced that they thought the new drop-dead date on a debt ceiling crisis is on or around October 18. Look, we recently did some work on this. We modeled it. We subjected the economy to 15 different scenarios of shock.

Even a small crisis, one like we went through 10 years ago in 2011, will create around a 1% drag on growth in the final quarter of the year. If it gets sufficiently difficult, it could put at risk 1.2 million jobs. And this is just around an expectation of a manageable crisis, one in which at the 11th hour they come to a conclusion.

Secretary of the Treasury Yellen was perfectly correct when saying that if anyone's considering default as an option, that's a catastrophic option. That would create the conditions for another great financial crisis like we lived through over a decade ago. And as somebody who survived that, believe me, we don't want to go back there.

- So, Joe, play out that scenario for me. If we hit the Friday midnight deadline, no deal in place, the government shuts down, what kind of impact are we looking at?

JOE BRUSUELAS: OK, so this week, we formally run out of money on the 30th. And then the Treasury continues to use the extraordinary measures to keep things going. What you've already begun to see is a move at the front end of the curve where investors have been avoiding debt that's maturing around Halloween. At that point, you begin to see a little bit more stress in credit markets, like you've seen today, and sort of the move of the 10-year Treasury above 1.5%.

So you start looking at that. You begin to think consumer confidence. You begin to think corporate confidence. You expect to see a pullback on fixed business investment. That is productivity enhancing investment around software equipment and intellectual property. Households begin to look at a budding crisis. They begin to pull back on consumption. And of course, exactly like what happened in 2011, we begin to be having talks about the credibility and the credit rating of the United States.

These are all things that we've been through. I was chief economist at another outfit back then. I had to help manage this. This is something again we can avoid.

It's really important to note here, this is a artificially induced crisis. This is not a function of mispricing allocation, misallocation of investment. This is just an artificial deadline that the political sector can go ahead and address. And I believe they will. That's the core baseline outlook here. But that will involve the reconciliation and the fiscal year budget. So we've got a real bumpy three weeks ahead of us here.

- And we're hearing from other analysts out there, one at your Asia group, putting the odds of this actually moving farther into a technical default at 1 in 5. And I guess people watching this, we've been talking about it for a few days. Now, this isn't the first time we've gone through this as a country. And inevitably, you want to see both sides kind of reach some deal to avoid what she's called a economic catastrophe. But 1 in 5 seems high. Is that higher-- is the risk here higher than what you've seen in years before?

JOE BRUSUELAS: Political risk analysts will use something called the "J curve" to estimate crises in governments. As an economist, that's a bit much. I'm thinking you're more on that 5% to 10% of probability. And that's more than enough to take this seriously. Right?

OK, first and foremost, simply because we get past September 30 does not mean we're in default. Just because we get up to the October 18, well, then you begin talking about a technical default, but not an outright default. So we have a long ways to go.

And as you guys will move through this, you're going to become-- you're going to be hearing from experts on the front end of the curve, the fixed income market, people who are quite quantitative. And so we'll begin to flesh this out and what it means across asset classes. But the common denominator is, as financial stress begins to build, it does impact the real economy. Households in business, that's where we don't want to go.