Economist Zandi: Default would cause ‘deep, dark’ recession

He predicted the consequences of not raising the debt limit on time would range from massive jobs losses to significant drops in the stock markets and the paralysis of programs such as Social Security. 

"It will do significant economic damage," he said. 

He argued that Treasury will have some difficult decisions to make as it runs out of enough cash to pay all of its bills. 

The looming question would then become — does the federal government pay foreign investors or the nation's retirees?

"Do you pay Chinese or Japanense investors and not grandma?," Zandi said. 

Despite the gloomy forecast, Zandi said that the expectation is that lawmakers won't let the debate carry past Oct. 17, when Treasury Secretary Jack Lew says he will run out of "extraordinary measures" to pay the government's bills.

"I can't imagine policymakers even going down that road," he said. 

Business leaders, who have urged lawmakers to avoid any political maneuvering and raise the debt limit to ensure the nation's solvency and credit rating, would stop hiring and that would lead to a sharp decline in consumer spending, he argued.

Plus, the constant stream of fiscal uncertainty is simply bad for the nation's already bruised psyche, he said.

"If they can't get together it opens an economic Pandora's box and it's hard to get it back together again," he said. 

Any delay would likely send interest rates soaring and would weigh on the healthier housing recovery, which has already taken a hit from rising interest rates that remain at historic lows, hovering around 4 percent for a 30-year-fixed-rate mortgage. 

The overall damage would mean negative economic growth in the final three months of the year, halting the recovery, Zandi said.

He said even if Congress arranges a short-term agreement to temporarily raise the debt ceiling, that would just create more uncertainty for businesses and would still stymie the economy. 

Zandi already expects anemic growth in the July-September quarter — between 1 and 1.5 percent. 

As it is, Congress is grappling with a government shutdown without any path toward resolution. 

Speaker John Boehner is headed for the White House later Wednesday to talk to President Obama about the latest standoff. 

House Republicans are insistent that any stopgap spending measure contain provisions to delay or defund Obama'a signature healthcare law. 

The Democratically controlled Senate and the White House disagree and have urged House GOP leadership to pass a "clean" continuing resolution to get the government back up and running. 

While the stock markets didn't react on Tuesday, the first day of the shutdown, Zandi expects that by the end week, the effects will be crystal clear. 

To exacerbate the problem, the Labor Department is not expected to release its September jobs report on Friday, which moves markets and provides a gauge of the nation's economic health.

"It will be a bad day regardless," Zandi said. 

Zandi expects that the government figures measuring public and private employment will be close to the ADP's private-sector data released on Wednesday, which came in at 166,000, right in the ballpark for the 150,000 to 200,000 average during the recovery. 

The unemployment rate is expected to tick down to 7.2 percent from 7.3, although that rate has dropped as people have stopped looking for work. 

If plans change and the report is released, it would provide "some solace to investors" and could stall a deeper slide that is expected next week if the government remains closed. 

"My sense is it will be a pretty bad day and by early next week, with no progress, the angst will build day by day mid to late next week."

Another consideration to weigh in this shutdown, the first in 17 years, is that the economy was in a much better place during the 1995-96 event and on the cusp of the technology and Internet boom that led to massive job creation.

These fiscal fights are expected to set back the Federal Reserve on any tapering plan, which probably won't start until early next year, Zandi predicted.

For that to happen, the economy will have to start cranking out about 200,000 jobs a month before the Fed makes any changes, he said. 

The economy will be unable to produce those kinds of numbers under the constant barrage of fiscal duress. 

The central bank surprised the financial markets recently by deciding to hold off on cutting back its $85 billion in monthly stimulus. 

In fact, Zandi his group and others have concluded that nearly nonstop fiscal uncertainty during past few years has cost the economy $150 billion in growth and 1 millions jobs. 

On top of that, the unemployment rate would be about 6.6 percent if Congress had been able to smoothly handle its fiscal fights. 

Still, Zandi argues that reality may not set in until financial markets drop sharply, which would probably happen by the end of the week. 

"We may need to see the markets drop several hundred points before lawmakers get message," he said.

"As soon as people lose money they'll scream loudly and set a fire under lawmakers. Until that day, I'm not sure if lawmakers will get it together."