An exercise in thinking about the unthinkable: a U.S. debt default

Zoom in: The One Big Beautiful Default assignment in Mitu Gulati's class at the University of Virginia School of Law is a hypothetical memo signed by "the President," who is unnamed.

• "Ladies and Gentlemen: I am writing to you in your capacities as experts in the resolution of sovereign debt crises," it reads.
• Foreigners have stopped buying U.S. Treasury bonds, and the government is "being forced to offer higher and higher interest rates" to get people to buy them, the president writes. That makes investors "yippy" and drives rates up more.
• Rates are at 15%, the president says, adding that he needs this fixed.

Zoom out: It's a scenario that has happened to much smaller nations.

• Argentina, for example, outright defaulted on its debt in 2001.

What they're saying: In the class exercise, the president proposes a deliberate kind of default. He says he wants to stop making payments on bonds to noncitizens and wants to minimize the negative effects such a move would have.

• Students have until the end of the semester to come up with a plan.
• "I desperately hope that we don't have to worry about it, but I think it's really stupid not to prepare," Gulati says.

The big picture: U.S. Treasury securities have long been considered the safest investments in the world — sometimes described as "risk free."

• A deliberate default or a political decision to punish certain holders of U.S. Treasurys "would destabilize the entire international financial system," says Lee Buchheit, a veteran sovereign debt lawyer who has worked with Gulati before and is familiar with the class assignment.

State of play: The U.S. is now paying higher interest rates to entice investors to buy its Treasury notes and bonds — the rate on the 30-year bond is back to levels not seen since 2007.

Friction point: There are signs, meanwhile, that investors — particularly foreign governments — are looking for alternatives to the U.S.

• The Netherlands shifted some of its gold from the U.S.
• Norway's sovereign wealth fund — the world's largest — is proposing to cut its exposure to government bonds, including U.S. Treasury securities.
• Foreign governments are holding a much smaller share of U.S. government debt, as Matt wrote recently.

Yes, but: At the moment, borrowing costs are rising not just in the U.S. but for most developed countries — all dealing with a mountain of debt.

• And there are some who argue that interest rates are now normalizing from the super-low levels that became the norm in the wake of the 2008 financial crisis.

Flashback: Worries over a U.S. default have cropped up before around debt ceiling standoffs.

• "We live in a moment in which a U.S. administration has been willing to deploy punitive tariffs on other countries for reasons that have nothing to do with trade policy," says Buchheit, who advised the Greek government in its debt restructuring — the largest ever at the time.
• "The proponents of those policies might just be tempted to entertain the possibility of a targeted default on debt held by an offending country," he says. But only if it wouldn't impair the market for U.S. debt, invite retaliation and could really be targeted.

The bottom line: "These are Himalayan ifs," he says. "I, for one, don't think this would be possible, but the OBBD exercise invites the students to indulge in what law professors like to call 'hypotheticals.'"

• "After all, bestselling books are written about the possibility, and the likely consequences, of thermonuclear annihilation."