The Debt-Ceiling Dilemma

Jennifer Yousif

Fixed Income Analyst

The din from the debt-ceiling debate is almost deafening, and it’s likely to get worse. Though the reality may not seem quite so bad when you understand the nuances.

The U.S. government has two primary sources of money to meet its spending obligations: Taxes and sales of bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. like Treasurys (issuing debt). But it can only issue so much debt before it hits the debt ceiling, a limit imposed by Congress. Congress also controls how much the government spends. When our obligations outpace the money raised from taxes and bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. issuance, something must give. Unfortunately, in today’s very partisan government, no one wants to blink first.

And so here we are, once again hitting the limit on borrowing. But there’s a caveat that keeps getting lost: The government can likely maintain enough wiggle room to meet its obligations until sometime this summer by using financial chicanery the Treasury Department describes as “extraordinary measures.” If that sounds familiar, well, yes, we’ve been here before.

When the debt ceiling comes into view, Congress is called upon to raise the debt limit, and it has always ultimately done so. Since 1960, Congress has raised, extended or refined the definition of the debt limit 78 times—49 times under a Republican administration and 29 times under Democrats.

So why all the handwringing now?

The debt ceiling is being leveraged as a bargaining chip between the two major parties. Republicans want to secure spending cuts before agreeing to raise the debt ceiling, while Democrats prefer the limit be raised without major spending concessions. If an agreement is not reached, there’s a fear that the U.S. will be unable to pay interest on its bonds sometime in the second half of the year and hence default.

Amid the rhetoric and finger-pointing, it should be acknowledged that both Democrats and Republicans have been responsible for the tax cuts and budget hikes that got us where we are today. Neither party is innocent in this debate.

But the result of a continued standoff could be disastrous. A first-ever U.S. default would shake investor confidence in what has been one of the safest securities in the world and “cause irreparable harm to the U.S. economy,” according to Treasury Secretary Janet Yellen.

I do not see that occurring.

In 2011, the debt-ceiling drama resulted in a political standoff on the floor of Congress and an eventual ratings downgrade of U.S. Treasurys by Standard & Poor’s, from AAA to AA. In my mind, that’s likely the very worst case we’re up against today—a possible downgrade as opposed to a default. The headlines are eye-catching, but the government always ends up increasing the debt ceiling.

Odds are high that it will come down to the wire before one side blinks. Bargaining chip or not, leaders in both parties have historically recognized that raising the debt ceiling is a necessity.