Debt Ceiling for Dummies: Why Compromise Is so Necessary

I offer the following straightforward, plain-English summary to hopefully help better explain the real-life impact of American credit default.
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As we approach August 2, the deadline for Congress to lift the debt ceiling before the nation begins to default on its credit, there's still considerable public confusion about what it all means.

While nearly every economic expert declares that default would be a disaster, and a bipartisan consensus of politicians not aligned with the Tea Party agree, the country is still sharply divided. The most recent Pew Research Center poll found that only 40 percent of the public felt it was "essential" to raise the debt limit, while 39 percent of Americans (including 53% of Republicans) felt that we could go past the August 2 deadline without major economic problems.

Why the disconnect?

Part can be attributed to the continuing and growing distrust of Washington politicians, particularly by those disaffected on the far right.

Much is also due to the esoteric, bewildering, and sometimes coma-inducing nature of the financial jargon and labyrinthine subject matter associated with the debt ceiling debate.

As a Democrat and a former state Treasurer and CFO, I'm probably not the right guy to convince the partisan-blinder-wearing Ceiling Deniers.

But for the rest of us, I offer the following straightforward, plain-English summary to hopefully help better explain the real-life impact of American credit default:

What is the debt ceiling?

When many Americans hear the term "debt ceiling," they compare it to the limit placed on their credit cards. Using this analogy, it would seem foolish to provide a higher limit to a shopaholic (Congress) that is already abusing its credit. Shouldn't we instead cut up their credit cards?

Unfortunately, it's not that simple. And it's probably more accurate to compare credit default with America burning up its credit card bills.

The debt ceiling is a statutory cap on the amount of debt the federal government has incurred. The federal debt is, in essence, the money the country has borrowed -- by issuing bonds and Treasury bills -- to operate all of its essential functions. Any new debt we must incur today is necessary to pay for programs we funded in the past. Lifting the debt ceiling, therefore, would not restrict future government spending -- instead, it would result in a failure to honor the debts we've already incurred through our prior spending.

That's simply irresponsible financial behavior -- for an individual, or for a nation. And that's why lifting the debt ceiling -- while often a political talking point -- has never been seriously contested: since 1980 alone, the debt ceiling has been raised 39 times, in Democratic and Republican administrations.

So what happens if we fail to lift the debt ceiling?

If the U.S. fails to lift the debt ceiling on August 2, the Treasury Department will begin on August 3 to determine which government payments will be prioritized to be made under the debt cap. In all likelihood, despite threats to the contrary, Social Security checks, Medicare payments, and essential government services -- including our national defense -- will be prioritized.

But federal spending in other categories could be dramatically downsized, with some government departments potentially shuttered. Looking at the 1995-6 federal government shutdown for examples, we could see a cessation of disease surveillance and toxic waste cleanup, closure of national museums and parks, cancellation of recruiting and training law enforcement officials, stoppage of visa and passport application processing (impairing the tourist and airline industries), and a significant curtailment of services to our veterans, ranging from finance and travel, to health and welfare.

Of course, we would have to expect such a scenario to be temporary. At some point, public outrage would force Congress to lift the debt ceiling in order to continue these critical, popular services.

But even in such a scenario, there would be lasting permanent damage, emerging primarily from the extreme likelihood that failure to lift the debt ceiling would result in the first credit downgrade in American history.

What's a credit downgrade, and what's so bad about it?

Since the first credit rating agencies were established, U.S. Treasuries have always enjoyed a triple A rating -- the very highest -- indicating to financial markets that they are among the safest investment instruments in the world. Standard & Poor's, one of the leading credit rating agencies, has recently warned, however, that a failure to lift the debt ceiling would likely result in its downgrading U.S. credit to the AA level.

Thanks to those awful free credit report commercials, most Americans understand that having a low credit rating is a bad thing. For individuals, low credit scores could result in the denial of credit for the purchase of homes, cars, and other critical items.

For the nation, the impact would be far worse, and much longer lasting. Initially, a national credit downgrade would signal to investors that U.S. Treasuries are a riskier proposition. This means that in order for the nation to borrow funds to pay for essential services, Treasury would have to provide investors with a higher interest rate to compensate for the additional risk they would be taking.

Once those interest rates begin to climb, investors will lose further confidence in the United States. A vicious circle spins wildly, resulting in even higher interest rate hikes. Accordingly, the U.S. would have to spend billions upon billions more dollars on interest payments, further ballooning the national debt, requiring even more drastic spending cuts and/or tax increases.

What an irony: the far right's refusal to agree to a debt ceiling increase -- in the name of fiscal conservatism -- would dramatically worsen our debt problems and make it much, much more difficult for the nation to address them.

It gets worse. Many individual states -- particularly those that rely on federal largesse and employment -- would experience their own credit rating downgrades. State coffers already stretched by reduced revenues in the Great Recession therefore would be depleted further by higher interest payments, necessitating likely state tax hikes and/or cuts in education, health care and law enforcement.

Finally, these interest rate hikes would not be limited to our governments' borrowing. They would immediately translate to higher interest rates on our credit cards and mortgages, directly reducing the incomes of hard-working Americans.

And higher interest rates are only the quantifiable impact of a credit rating downgrade. Ultimately, the United States' position as the world's economic leader would be seriously undermined.

Why would credit default threaten our economic leadership, and why is that important?

America's economic standing in the world would certainly suffer if it defaulted on its obligation to repay its debts to other countries. Not only would this be the first time the U.S. had been in default: No nation has ever voluntarily defaulted on its credit obligations in the world's history. As European leaders desperately attempt to protect themselves from the ramifications of a potential Greek bankruptcy, they must shake their heads in bewilderment to watch America drive towards to brink of default for no reason other than hyper-partisan brinkmanship. How could anyone ever again trust America's full faith and credit assurances?

Meanwhile, in the case of a credit downgrade, all of the global institutions that by policy or by statute invest only in the safest triple-A rated bonds -- such as many pension funds and investment trusts -- would be forced to dump their U.S. holdings. This would necessarily shift financial transactions away from U.S. institutions, and ultimately could result in the dollar losing its status as the world's reserve currency, a major blow to American global financial leadership.

What can I do?

Don't ever underestimate the power of the citizenry in our democracy. We are at the brink of credit default because the loudest voices that our elected representatives are hearing come from the extremes of our political system. If the rest of us make ourselves heard -- and polls show that a clear majority of Americans support bi-partisan compromise -- Congress will listen.

So call, write, and email your Congressmen. Educate your neighbors and encourage them to join in the advocacy. And if you are looking to join a grassroots effort aimed at restoring bipartisanship and common sense in Washington, join us at No Labels, a new national movement of Democrats, Republican, and Independents, all of whom agree that we must put aside our labels on occasion to work in the country's best interests. Click here to stand with No Labels in demanding a bipartisan solution to the debt crisis.

But whatever you do, act today. Time is running out, and should the worst case scenario occur, the genie cannot be placed back in the bottle. It is up to each of us to insist that our leaders stand back from the brink, and do what is right for the nation.

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