Image: Economic fallout © Photographers Choice RF, SuperStock

Ask Jay Powell how the average consumer would be affected if Congress doesn't vote to raise the debt ceiling before Aug. 2, and he responds with his own question:

"Did that consumer lose his job?"

That's a good possibility if the consumer happens to work for the federal government, for a defense contractor that doesn't get paid or for a company that needs credit to keep going.

It could also be big trouble for anyone who needs a car, needs a home or student loan, uses a credit card, has a retirement savings account or wants to travel abroad.

Not raising the limit on how much the U.S. government can borrow -- now set at $14.3 trillion -- would be "an enormous economic event," said Powell, who was undersecretary of the Treasury for the first President Bush and now works at the Bipartisan Policy Center, a Washington, D.C., think tank. He is an author of the center's analysis of the debt-limit situation (.pdf file).

The analysis estimates that without authorization to borrow, the federal government would take in about $203 billion in revenue but have $362 billion in bills to pay.

So choices would have to be made on what got paid. Interest on outstanding debt would take priority to avoid default and damage to the U.S. credit rating. Beyond that, should the government pay Social Security benefits but not the salaries of servicemen and servicewomen on active duty? Medicare and Medicaid payments but not federal workers' salaries and benefits?

The U.S. government has 80 million bills due in August, and, no matter what choices are made, about 40% to 45% of them won't get paid unless more borrowing is authorized.

"When you take away all that spending, it will have a huge effect on the broader economy," Powell said.

Impact on interest rates

And if the U.S. government doesn't pay back the $500 billion in debts coming due in August -- or at least pay the $29 billion in interest on those loans -- that default is going to cause havoc in the economy's credit sector, which will eventually reach down to anyone who needs to borrow money or uses a credit card.

How much interest is charged on a loan is determined by an assessment of the chances of the money being repaid. Lending money to the U.S. government, by buying Treasury bonds, has been rated as one of most risk-free investments available, which means the government pays a small amount of interest on the money borrowed.

Moody's Investors Service, Standard & Poor's and Fitch have said that a default would prompt them to downgrade the United States' credit rating from the top-ranked Aaa. But simply raising the debt ceiling, without getting the nation's debt problems under control, might not be enough to prevent a downgrade, the ratings agencies have indicated.

Treasury bonds provide the floor for other lending -- car and home loans, credit card debt and student loans, for instance. And because those loans are seen as more risky, the interest charged on them is higher and could rise faster than an increase in the rate on U.S. securities.

How much those interest rates might go up would depend to a large extent on perception, said John Praveen, the managing director of Prudential International Investment Advisers in Newark, N.J.

"It's not so much how much but how fast" interest rates change, he said.

For example, if the rate on 10-year Treasury bills went up half a percentage point, Praveen doesn't think there would be much impact, since the rate is low already (3% to 3.5%). But if the rate increased quickly by 1 or 2 points, the perception in the equity markets would be that the rate would keep going up.

"There would be uncertainty because you don't know if the increase will continue; you don't know the endgame," Praveen said.

A 1% spike could cause problems. For example, Praveen said that given the high correlation between mortgage rates and the Treasury yields, homebuyers could expect a one-to-one increase in mortgage rates.