Debt ceiling fight risks fiscal disaster
Like a recurring bad dream, the debt ceiling is back in the news. The periodic political spasm over increasing the amount of money that the government is authorized to borrow to meet its existing legal obligations is not new, but because it comes on the tail end of a global pandemic, it seems horribly ill-timed.
The Treasury Department underscores that “the debt limit does not authorize new spending commitments. It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past.” In other words, lawmakers have already agreed to fund everything from tax cuts in 2017 to COVID emergency measures in 2020 and 2021, on top of the ongoing commitments to Social Security and Medicare, military salaries and interest on the national debt. The Congressional action being contemplated simply makes good on Uncle Sam’s existing obligations.
The seemingly arcane process goes back a century, to the Second Liberty Bond Act. According to historian Heather Cox Richardson, this law allowed Congress to authorize “a general amount of debt during World War I to give the government more flexibility in borrowing by simply agreeing to an upper limit rather than by specifying different issues of debt, as it had always done before … while a measure to fund the government is forward looking, enabling the government to spend money, a measure to raise the debt ceiling is backward looking.”
Not raising the debt limit forces Treasury to make a series of bad choices, including shutting down non-essential government services (national parks and museums would close, and the collection and publication of vital economic data would cease), furloughing 500,000 or more non-essential government workers (with another 500,000 to one million being forced to work temporarily without pay), and delaying Social Security checks.
Once those options are exhausted, the government would face fiscal DEFCON 1: a delay, reduction or (gasp) a missed payment on government-issued bonds, something that has never occurred. The situation would call into question the full faith and credit of the United States as an entity that always meets its financial obligations. A decade ago, in August 2011, just the potential of fiscal DEFCON 1 prompted ratings agency Standard & Poor’s to issue its first-ever downgrade of US debt from AAA to AA+, which then caused US stocks to fall by 14% in the subsequent four weeks.
Treasury Secretary Janet Yellen has warned that a default “would likely precipitate a historic financial crisis that would compound the damage of the continuing public health emergency. Default could trigger a spike in interest rates, a steep drop in stock prices and other financial turmoil. Our current economic recovery would reverse into recession, with billions of dollars of growth and millions of jobs lost.”
Moody’s Analytics put it bluntly: A default would be “cataclysmic” and would cause the economy to “descend back into recession.” How bad could things get? Moody’s projects “nearly 6 million jobs would be lost, and the unemployment rate would surge back to close to 9%. Stock prices would be cut almost in one-third at the worst of the sell-off, wiping out $15 trillion in household wealth. Treasury yields, mortgage rates, and other consumer and corporate borrowing rates spike, at least until the debt limit is resolved and Treasury payments resume.”
Given the fragility of the post-COVID economic recovery, a debt ceiling debacle would be disastrous, which is why most believe that Congress will jump in and raise the limit, as it has done 78 separate times since 1960 (49 times under Republican presidents and 29 times under Democratic presidents). Let’s hope so.
Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes questions at askjill@jillonmoney.com. Check her website at www.jillonmoney.com.