What the Deficit Fight Means for You

July 13, 2011 -- If Congress fails to raise the U.S. debt ceiling, what will be the consequences for U.S. savers and investors? Two economists at the Center for American Progress, a progressive advocacy group, believe the consequences could be dire.

The stock market, they say, could drop by 20 percent to 30 percent. And 401(k)s, which in the past two years have rebounded from losses suffered earlier in the recession, could see those gains largely erased.

Today, Wall Street issued Washington an ominous warning when Moody's said it would put the United States on review for a downgrade if there is not substantial progress on a debt deal by mid-July.

Gloria Moss, 65, an educator in Florida, lost about half the value of her 401(k) in 2008, when the economy turned sour and the stock market fell. By this May, thanks to a stronger market and the help of a financial planner, she had recovered about 75 percent of what she'd lost.

A report by financial services company Fidelity Investments found that by the end of the first quarter, the average 401(k) balance had surged past where it was before the recession. It's exactly these gains, said the two economists, that are in jeopardy if the nation's debt ceiling isn't raised.

Sixty million Americans have a 401(k)-type plan totaling $4.7 trillion, or about $74,000 per account. ABC News spoke with 11 financial analysts at the country's biggest investment companies. All the analysts said it's a good time for people to watch their portfolios carefully, but too early to make any moves.

Jeff Kosnett, a senior editor at Kiplinger's Personal Finance, told ABC News a good indicator to keep track of is the 10-year Treasury yield, the price of government debt.

"If that starts edging up and going sharply higher in the next couple weeks, that's a signal that perhaps the confidence that this budget crisis can be averted isn't really that strong, and then you have to worry," said Kosnett.

Heather Boushey and Christian Weller, economists at the Center for American Progress, expressed their views, respectively, in testimony before Congress in July and in a May white paper.

Boushey predicted that allowing the economy to "slam into the debt ceiling will undoubtedly create an immediate economic shock," with disastrous consequences for the job market. Government, unable to borrow, would need to reduce spending immediately by 40 percent. The same shock, she believes, would trigger a sharp fall in the stock market.

"Families with 401(k)s would likely lose all the gains they have made in 2010 and much of their gains in 2009, moving them further below where they were at the end of 2007 after the stock market fell sharply," she said.

The blow would be felt most painfully by baby boomers of retirement age, since this generation, unlike previous ones, is more dependent on market-sensitive 401(k) savings than on fixed pensions.

"These families are more vulnerable to what goes on in the financial markets," she told ABCNews.com.

The hit to 401(k)s, coupled with what she said would be a further decline in home prices, will deal the middle class a double whammy. Near record-breaking unemployment rates would make it difficult for older, unemployed boomers to work their way out of their retirement hole.

Of the ongoing struggle in Congress over what to do about the debt ceiling, Boushey's colleague, Christian Weller, wrote: "What may seem like an esoteric debate far removed from people's lives could in the end become a major setback for families' economic security."

Given that almost 60 percent of 401(k) money is invested in stocks, he said, a 20 percent market drop would cost the average saver $7,911; a 30 percent drop would cost almost $12,000.

How much any individual's 401(k) would be affected by a market drop would depend, of course, on how the money had been invested.

"It all depends on what you have your money in," said James Sorrell, a self-employed travel industry executive whose company, New York TAB, promotes tourism in New York City.

Though Sorrell's 401(k) took a hit at the start of the recession, it's rebounded 28 percent in the past two years.

"That's because I shifted a lot of money to Fidelity's defense and aerospace fund," he said. "It's done marvelously for me, so long as we're at war."