The federal debt ceiling is back in the spotlight as Senate Democrats forge ahead with massive spending and infrastructure bills.
While the legal cap on how much the U.S. can borrow doesn’t impact what consumers can spend, if Congress can’t reach a deal on a new debt limit next month, it will wreak havoc on everything from credit cards to car loans.
“It’s a financial game of chicken,” said Mark Hamrick, senior economic analyst at Bankrate.com.
Where we stand
For starters, the federal debt is the amount of money the government currently owes for spending on payments such as Social Security, Medicare, military salaries and tax refunds.
The debt limit allows the government to finance those existing obligations.
“Increasing or suspending the debt limit does not increase government spending, nor does it authorize spending for future budget proposals; it simply allows Treasury to pay for previously enacted expenditures,” Treasury Secretary Janet Yellen said in a statement Monday.
Congress and the White House have changed the debt ceiling almost 100 times since the end of World War II, according to the Committee for a Responsible Federal Budget. In the 1980s, the debt ceiling increased to nearly $3 trillion from less than $1 trillion. During the 1990s, it doubled to nearly $6 trillion, and doubled again in the 2000s to over $12 trillion.
In 2019, Congress voted to suspend the debt limit until July 31, 2021. Now, the Treasury is using temporary “emergency measures” to buy more time so the government can keep paying its obligations to bondholders, veterans and Social Security recipients.
But once the government exhausts those measures, it will no longer be able to issue debt and could run out of cash-on-hand.
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Of course, the U.S. government has never actually defaulted on its debt and isn’t expected to this time, either. Yet, the threat of defaulting has come up many times.
And even that has its consequences.
Some economists had hoped Senate Democrats would include a debt ceiling increase as part of the $3.5 trillion spending plan released Monday.
But the budget resolution left out the ceiling entirely, and the government will be near the brink of default once again when the Senate returns from its summer recess midway through September.
What’s at stake
In the worst-case scenario, the federal government would default, at least temporarily, on some of its obligations, including those Social Security payments, veterans’ benefits and salaries for federal workers.
In addition, potential downgrades of U.S. credit ratings would hammer Treasurys. Demand for U.S. Treasury bonds could sink if they are no longer considered a reliable, safe-haven investment and bondholders would demand dramatically higher interest rates to compensate for the increased risk.
That, in turn, would send other borrowing costs higher, including credit cards, car loans and mortgage rates, which generally are pegged to yields on U.S. Treasury notes.
At the very least, fear of default could rattle the stock market and send shock waves throughout the economy, according to Bankrate’s Hamrick.
“If you go back to a decade ago, there was an immediate selloff in the financial markets — it hit investors hard and runs the risk of a cascading financial crisis,” he said.
Just the uncertainty can impact borrowing terms and borrowing availability.
Yiming Ma
assistant finance professor at Columbia University Business School
In 2011, a debt limit standoff in Congress brought the country very close to a default before lawmakers finally struck a deal, but not without a downgrade of the country’s credit rating and significant market volatility.
Between July and October of that year the S&P 500 sank more than 18%.
This time, lenders may start tightening their standards in advance to reduce their exposure — or risk — during what could be a contentious battle next month, said Yiming Ma, an assistant finance professor at Columbia University Business School.
“No one thinks it’s going to be a straight default but even just the uncertainty can impact borrowing terms and borrowing availability,” she said.
“If I was someone about to take out a loan, I would look at the terms now,” Ma added. “In the last days, there could be a frenzy going on.”
