Citigroup Calls Debt Crisis 'Insanity'

NEW YORK ( TheStreet) -- A U.S. debt default triggered by a failure to raise the Federal debt ceiling would be an act of "collective insanity", Citigroup ( C) economists said in a report Thursday.

Descriptions of a default as a calamity, Armageddon, suicide or insanity is not mere hyperbole, Willem Buiter and Ebrahim Rahbari argue in their note.

"The damage would be so severe, because a default due to a failure to raise the Federal debt ceiling is neither a conventional 'can't pay' default (the country does not have the resources to service the Federal debt in full) nor a conventional 'won't pay' default (when a solvent united government and country "cocks a snook" at its external creditors), but a needless default - we have the resources to honor the debt, we really did not want to default, but we were so busy fighting among ourselves that the deadline passed," the economists wrote in a note.

While most economists still believe a default is unlikely, the probability of the event happening is no longer "negligible", the report said. And even if Congress does raise the debt ceiling, a modest downgrade to AA appears likely at this point.

The consequences of a downgrade to AA won't be as severe as a default, according to the economists, but they would be substantial. The direct response to such a downgrade would result in forced selling by investors with requirements to solely invest in AAA rated securities and an automatic downgrade of assets linked to the US sovereign rating.

Indirectly, it would increase sovereign and private funding costs, heighten risk aversion and reduce faith in the U.S. dollar and Treasuries as safe-havens.

"It is hard to see how the US can overcome the unavoidable fiscal challenges without either experiencing a sovereign debt and US dollar crisis or a recession caused by significant fiscal tightening, or both," they said.

--Written by Shanthi Bharatwaj in New York

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