Debt Ceiling Decoded: What You Need to Know

Confused by the debt ceiling debate? Here are the basics.

Federal Reserve Board Chairwoman Janet Yellen answers questions at a news conference following a Federal Open Market Committee meeting September 17, 2015 in Washington, DC. The committee reaffirmed its view that the current target range for the federal funds rate remains appropriate and that interest rates will remain unchanged.

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The U.S. could run out of cash to pay its bills by June 1, Treasury Secretary Janet Yellen warned on Monday, if Congress doesn't raise or suspend the debt ceiling.

In response, President Joe Biden will meet with the top four leaders in Congress on May 9 to discuss fiscal issues. Speaker Kevin McCarthy, the minority leader Representative Hakeem Jeffries, majority leader Senator Chuck Schumer, and minority leader Senator Mitch McConnell will be pressured to reach an agreement to avoid defaulting on the nation's debt.

The U.S. federal debt has almost doubled in the past decade to $31.4 trillion. Economists predict that a failure to raise the debt limit could throw the global and U.S. economy into a financial crisis. The portion of that debt owed to the public—individual investors, financial institutions, and foreign governments that lend money to the U.S.—is 95% of U.S. gross domestic product.

In other words, the amount of money the U.S. government now owes to outside sources essentially equals the size of the entire U.S. economy.

Yet the federal government still doesn’t have enough money to pay its current bills and interest on the money it has borrowed. So it needs to borrow more.

In the meantime, it has made promises, many enshrined by law, to fund Social Security, Medicare, and other federal government programs. It must also pay interest on the money it already owes.

What's the Debt Ceiling?

The debt ceiling establishes the maximum limit on the U.S. Treasury’s outstanding debt.

Before 1917, the U.S. government needed Congressional permission each time it borrowed money. During World War I, Congress established the debt ceiling to give Treasury the flexibility to sell Liberty Bonds to help finance the U.S. war effort.

Since then, for the Treasury to keep issuing bonds to finance previously authorized government outlays, the limit routinely gets increased.

Raising the debt ceiling doesn't authorize new government spending; only Congress can do that via its annual budget process. Increasing the debt limit only affects the ability to pay debts the government has already incurred—including promises bound by law to fund Social Security and

Does the U.S. Need to Raise its Debt Ceiling?

To avoid potentially missing payments to creditors, yes. Yellen has repeatedly warned Congress that the federal government has reached its borrowing limit. In January, she said the Treasury would take “extraordinary measures” to ensure it can keep making required payments to its public creditors.

Those measures include suspending debt sales to fund certain items, Yellen said, and probably should allow Treasury to meet debt obligations through early June, but she has revised that timeline. Yellen urged Congress to "act promptly to protect the full faith and credit of the United States."

Has Congress Previously Raised the Debt Ceiling?

Since 1960, Congress has raised the debt ceiling 78 times, including 20 times since 2001. In recent years, increasing the debt ceiling has ignited partisan bickering, leading to Congressional standoffs that pushed the Treasury ever closer to exceeding its statutory borrowing capability.

What Would Happen if the U.S. Defaulted on its Debt?

A default would mark an unprecedented event, with implications not just for the U.S. Never before has the world’s leading economy, one that issues the world’s primary currency and its safest bonds, failed to meet its payment obligations.

Retired adults likely wouldn't receive Social Security checks, members of the U.S. military along with federal employees ranging from postal carriers to air traffic controllers might not get paid, government food assistance payments may get halted, and checks for government and veterans’ pensions could halt.

If a default occurs, Moody’s foresees a “cataclysmic” U.S. economic downturn comparable to the 2008-09 global financial crisis.

The economy, Moody’s said, would lose an estimated 6 million jobs, almost tripling the unemployment rate to 9%, and household wealth would plummet by $15 trillion with a third of the nation’s stock market value evaporating.

In an environment of rising interest rates, borrowing costs for all types of consumer loans—ranging from mortgages to credit cards—would rise even more, and corporations would face higher borrowing expenses.

Even if financial markets and the economy eventually recovered from default, it would have one lasting, damaging impact: Investors no longer would consider U.S. debt “risk-free,” as they have for the past century.

That would permanently push up the federal government’s borrowing costs, making it even more difficult to service its existing debt.

How Have Debt Ceiling Debates Affected U.S. Government Credit?

In the 20th century, Congress usually increased the debt limit with little fanfare. Before 2011, debt ceiling debates didn't hurt the Treasury's credit, and it enjoyed the highest rating possible from agencies that assess publicly traded bonds.

But amid that year's acrimonious debt-ceiling fight in Congress, Standard & Poor’s cut the U.S.'s AAA credit rating—the highest rating possible—to AA+ for the first time in 70 years. The U.S. still maintains that lower rating today.

Since then, continued U.S. spending has required Congress to raise the debt ceiling six more times.  Each time, Congress waited until a few weeks or even days before the existing ceiling’s statutory deadline before raising it.

How Have Financial Markets and the U.S. Economy Reacted?

In the past dozen years, the periods immediately preceding Congressional agreements to raise the debt ceiling have prompted anxiety among investors as the deadline for raising the limit edged closer.

Bond prices generally fall as yields rise, and stock prices tend to struggle, particularly in the financial sector, which often uses and accepts Treasuries as collateral for loans.

Studies by the Federal Reserve found that the 2011 and 2013 debt-ceiling “episodes” caused Treasury yields for all maturities to rise 4 to 8 basis points, pushing the Treasury’s borrowing costs up $250 million each time.

Excess yields on short-term T-bills during those episodes peaked at 46 basis points in 2013 and 21 basis points in 2011, the Fed found. A General Accounting Office report, meanwhile, estimated the 2011 debt limit fight pushed the Treasury’s borrowing costs up $1.3 billion for debt maturing that year.

Looking back further, a Moody’s analysis found that when the Treasury inadvertently missed some T-bill payments in 1979—a mishap caused partly by delays in raising the debt limit—T-bill yields immediately surged 60 basis points and remained elevated for months, raising U.S. borrowing costs by $40 billion in today’s dollars.

That same analysis found that the uncertainty caused by the 2013 debt ceiling fight cost the U.S. economy $180 billion in lost output, reducing gross domestic product by a full percentage point and job creation by 1.2 million.

Article Sources
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