A Debt Default is Dangerously Close. What we Couldn’t Learn Last Time

Congress’s latest slow-motion game on the nation’s debt ceiling, with the government on the verge of running out of money in mid-October, raises the gruesome specter of the D word.

Default. In several recent standoffs over the ceiling, including the one in 2011 that led to a ratings downgrade, we found a way to pay the bills before the cash ran out. It would be unprecedented for the U.S. to fail to meet its obligations, many in the media and in government have said.

Or almost unprecedented. In a little-covered episode in 1979, the Treasury stiffed a group of T-bill investors of $122 million. At least, it failed to get the money to the holders on time amid a computer backlog. Eventually all were repaid, with interest, some waiting more than 10 days for their checks to arrive.

Technically a default and, though small, that brief nonpayment would have consequences. “The delays have resulted in a flood of complaints to district Federal Reserve Banks,” wrote Edward P. Foldessy, The Wall Street Journal‘s longtime markets reporter who broke the story on May 9, 1979. Foldessy noted that it was “especially embarrassing because U.S. Treasury securities are considered the world’s safest and most liquid investments.”

Foldessy’s article was no bombshell. It ran on Page 8 and treated the episode as something of a one-off, the result of “an embarrassing back-office crunch.” The word “default” doesn’t appear. The Journal ran just one follow-up article (more on that below). The New York Times‘ only mention was a four-paragraph chuckler, on May 20, headlined “Back-Office Snarl.” Barron’s never wrote about it.

It might have gone even further unnoticed if not for a lawsuit and, 10 years later, an academic study that determined the default resulted in “a one-time, permanent ratchet upwards of yields.”

What would happen today if the U.S. defaulted? This episode provides something of an answer, and Foldessy got right to the heart of the reason.“I’ve lost confidence in the direct purchase” of T-bills, Daniel Beck, a Detroit investor who still hadn’t been paid, told the Journal reporter. “I might use my money in another area, such as corporate paper.”

Confidence was already in short supply in 1979, with runaway inflation driving the U.S. into recession and Congress having just staged a now-familiar battle over the debt ceiling. This mini-default only added to the negative outlook, even if the cause was a bureaucratic screw-up and not the debt-ceiling standoff itself: a new data-processing system was overwhelmed by heavy demand, with the three-month T-bill yielding over 9% vs. the standard deposit account offer of 5.25%.

The victims were mostly small investors, who were to be paid with actual paper checks—wire transfers were used for large financial institutions—but the checks simply weren’t processed in time.

“For a $10,000 investor,” the Times calculated, “the potential loss in income at current interest rates for 11 days is about $30.”

Not a lot of money, but enough to rouse Claire G. Barton. Represented by her lawyer-husband Sidney—the retired couple lived in Encino, Calif., at the foot of the Santa Monica Mountains—the 71-year-old Mrs. Barton filed a class-action suit against the U.S. in federal court.