Default Scenario Looms Larger as Budget War Rages : Treasury: Idea that the government would not be able to pay its debts is no longer ‘unthinkable.’ ‘The bus is near the edge of the cliff,’ one official warns.

WASHINGTON —  It is often described as “unthinkable,” an absurd fantasy of the financially paranoid or politically naive: America in default.

Yet the risk that the U.S. Treasury will be unable to pay its debts in the near future has crept at least into the realm of possibility, as Congress and the White House engage in a high-stakes budget duel that so far has defied solution.

“The bus is near the edge of the cliff--and what this is doing is taking away the brakes,” a senior Treasury Department official lamented Wednesday, referring to a House plan to make it much harder to operate under the government’s credit limit of $4.9 trillion.

Further inflaming matters, House Republicans are trying to attach strings to a bill to increase the debt ceiling. One proposal, for example, includes in the debt-ceiling legislation a provision abolishing the Commerce Department, which the White House opposes deeply.

Beyond the ongoing machinations, questions are being uttered that seemed almost unimaginable just days ago: Could partisan political pressures somehow force the United States into a humiliating financial default for the first time in its history? And what would that mean for the nation?

While such an outcome remains unlikely, according to most observers, the danger of a serious financial crisis has increased. The Treasury Department will owe $24.8 billion in interest payments on Nov. 15, and officials said it is becoming increasingly hard to see how the government can meet all its obligations by then.

“If they send President Clinton the debt limit increase with some rider [condition] on it, what’s he going to do?” asked Martha Phillips, executive director of the anti-deficit Concord Coalition. “That’s where you could get to a showdown.”

In a matter that is technically separate from the debt limit, the House approved a temporary budget Wednesday to keep the government operating through Dec. 1. Without such legislation, which now goes to the Senate, the government would grind to a halt while lawmakers thrash out a fiscal 1996 budget, which should have gone into effect Oct. 1.

It is the debt limit, however, that seems to pose the greatest risk of financial turbulence. In the most extreme scenario, Republican leaders would be forced by their own membership to pass a debt-limit bill with attachments that the White House cannot abide. Clinton would then veto it, goes the reasoning.

And under such circumstances, the unthinkable might become thinkable: One day around Nov. 15, the sprawling financial machinery of the federal government would be forced to a clunky halt.

If that happens, the Federal Reserve will be faced with difficult decisions. With the stream of revenue from taxes and fees insufficient to meet all of the government’s obligations, the Fed will have to decide whether to accept U.S. government checks--and which ones to honor.

As if in a bad dream, all Americans who rely on those payments--Medicare beneficiaries, soldiers, welfare recipients, defense contractors, investors in Treasury bonds, vendors and many others--will confront uncertainty. Government agencies might be forced to shut down while the Administration establishes priorities for who gets paid, budget experts say.

In theory, federal officials could sell off assets, including minerals, forests or even the gold in Ft. Knox. Yet like much else about an unprecedented U.S. default, legal fine print, time-consuming procedures and political judgments would greatly affect what unfolds.

“You don’t just put an ad in the newspaper that says, ‘Would you like to buy a piece of Yellowstone National Park?’ ” said Robert D. Reischauer, ex-head of the Congressional Budget Office.

Financial markets would be rocked, most analysts believe, with the dollar’s value plunging and interest rates rising to reflect the anxiety of investors.

The short-term dislocations would depend, of course, on the length of the crisis, although many fear that a first-ever default by the U.S. government would have long-term effects.

Even a hike of one-tenth of a percentage point in interest that the government pays for future borrowing would add $15 billion to the budget deficit over six years. It would hit U.S. pension funds immediately, pushing down the value of their bond portfolios by $8 billion, according to a Treasury Department analysis.

“None of these [politicians] in their wildest dreams could possibly want all the criticism that would befall them” in a default, said Philip Braverman, chief economist at DKB Securities, a New York investment firm.

William V. Sullivan Jr., director of money market research at Dean Witter Reynolds, agreed: “I think most prudent analysts sense that default would be a deep and serious blemish on the creditworthiness of the U.S. government.”

The Clinton Administration is asking Congress to raise the debt cap by $67 billion to cover the next several weeks, for the simple reason that government expenditures routinely outpace revenues. And that will remain a fact in Washington until at least 2002, the year by which Republicans are aiming to have a balanced federal budget.

What has supercharged the debt-limit issue has been the GOP campaign to use any increase as a lever to force the Administration to accept its budget priorities. Earlier this week, the House Ways and Means Committee increased the pressure by passing a bill to prohibit the Treasury from employing one key method to stay below the debt ceiling: borrowing cash daily from a large civil service retirement fund that it pays back with interest.

A Treasury official accused Republicans of trying to “hijack” the budget debate “by holding the financial credibility of the United States hostage” to their goals.

House GOP leaders have argued that the effects of a default on financial markets would be surprisingly mild because people recognize that the debt-limit issue is primarily about politics.