"We can't even imagine all the things that might happen, just like Henry Paulson couldn't imagine all the bad things that might happen if he let Lehman go down," said Bill Isaac, chairman of Cincinnati-based Fifth Third Bancorp and a former chairman of the Federal Deposit Insurance Corp., referring to the former U.S. Treasury secretary. "It would create chaos in financial markets."
Higher borrowing costs could slow the housing recovery. If 30-year mortgage rates climbed to 6.5 percent from 4.5 percent, a borrower who can now afford the monthly payment on a $200,000 loan would only be able to take on about $160,000 of debt when buying a property, forcing down sale prices.
It would be "bad — both for affordability and for consumer confidence," said Jed Kolko, chief economist for Trulia Inc., an online property-listing service.
Banks would have to write down securities on their books that are losing value and face capital shortfalls, according to MIT's Johnson.
"The government wouldn't have the cash to rescue the banks this time either," Johnson said.
About half of the U.S. debt is held by foreign governments, central banks and other overseas investors, according to Treasury data. A default would throw those holdings into question as well as the dollar's status as the world's reserve currency, Johnson said. During the 2011 debt-ceiling scare, foreign investors shunned Treasury auctions for about three months, according to data compiled by JPMorgan.
China is the largest holder of U.S. Treasuries, with $1.3 trillion in July, according to Treasury data. Japan follows with $1.1 trillion.
Even if Treasury prices aren't affected by a default, the damage in other markets could be devastating. U.S. stocks fell 7 percent in one day when Congress rejected the government's bank- rescue package in 2008, before passing it a few days later.