Congress Is Holding The Debt Ceiling Hostage Yet Again. Here's Why That's Still Scary.

The good news: Markets have gotten used to our dysfunctional political system.
Treasury Secretary Jack Lew has asked Congress to "raise the debt limit without delay."
Treasury Secretary Jack Lew has asked Congress to "raise the debt limit without delay."

The United States will reach its legal debt limit on Nov. 3 if Congress does not act to increase it.

What would the dangers be, in that scenario? It depends on how quickly the impasse is resolved and how investors react.

“If it looks like it will be done in three days, there will be limited impact,” said Edwin Truman, a senior nonresident fellow at the Peterson Institute for International Economics who served as an assistant secretary of the Treasury from 1998 to 2001. “If it looks like there will be a stalemate, that is when you get a real problem.” 

Here's what you need to know.

What is the debt limit?

Congress created a limit on federal government debt in 1917. Before that, the federal government required congressional authorization for each individual loan it took out.

The federal government cannot spend money without congressional authorization. The national debt limit does not affect how much money is allocated to different areas of the government -- defense, health care or national parks, for example. All of those funding levels have already been set by Congress, either through laws mandating spending on certain programs, or through an annual congressional appropriations process.

So when Congress extends the debt ceiling, it isn't spending new money. It's signing off on the borrowing needed to finance the debts it has already incurred.

Historically, the debt ceiling has not been the subject of partisan brinkmanship. Congress has raised the debt ceiling 78 times since 1960, according to the U.S. Department of the Treasury.

In the 1980s, congressional Democrats occasionally asked President Ronald Reagan for budget concessions in exchange for a debt limit increase, but as Dave Weigel reported for Slate in 2013, Dems never seriously threatened to vote down an increase and always compromised with Reagan days after making their demands.

Only since the GOP took control of the House of Representatives in 2010 has raising the debt ceiling ever seriously been in doubt. House Republicans have demanded massive spending cuts in exchange for an increase, and have shown their willingness to allow the country to hit the ceiling. In August 2011, House Republicans refused to approve a debt limit hike until two days before the U.S. would have hit its limit. In October 2013, House Republicans again blocked a debt ceiling increase until days before the deadline.

Now congressional Republicans are once again trying to use the debt limit to extract concessions from the Obama administration. Rep. Mick Mulvaney (R-S.C.) said this week that the conservative House Freedom Caucus will not support a debt limit increase unless it's accompanied by major spending cuts.

Where are we now?

Treasury Secretary Jack Lew said Monday that on Nov. 3, the Treasury will have exhausted all the “extraordinary measures” it's been using since March to meet obligations without reaching the current debt ceiling of $18.1 trillion. (Strictly speaking, we already reached the limit in March.) 

After that, the department will begin drawing down some $30 billion in reserves, which Treasury told Congress is only about half of what it must spend on certain days.

“Hundreds of government agencies send their bills to the Treasury to pay,” said Truman, who was also an economist at the Federal Reserve. “And Treasury officials do not know the exact schedule.”

House Republicans are voting on a bill this week that would increase the debt limit while also mandating a vote on a balanced budget amendment and barring enactment of new regulations through July 2017. Senate Republicans have said they are waiting to see what the House passes before deciding how to proceed. 

President Barack Obama has vowed to veto any bill that does not provide for a "clean" debt ceiling increase -- that is, one that doesn't demand policy concessions, including the House Republicans’ proposed budget reforms. That sets the stage for a showdown that jeopardizes the Nov. 3 deadline. 

What are the risks?

Defaulting, or even falling behind on some payments, risks undermining the “full faith and credit” -- or creditworthiness -- of the United States government.

Creditors’ trust in the United States as a borrower rests on an understanding that the U.S. always repays its debts.  

“The creditworthiness of the United States is an essential component of our strength as a nation,” Lew wrote in a letter to congressional leaders last week, urging them to “raise the debt limit without delay.”

Protecting the “full and faith credit” of the U.S. has become the rallying cry of Democrats trying to pass a clean debt ceiling increase.

It may sound like an abstract concept, but the problems with eroding the country’s full faith and credit are practical. If the rest of the world comes to believe the U.S. can't be trusted to pay its bills, lenders will eventually increase the country's borrowing costs. Interest rates on U.S. debt would go up, costing taxpayers billions of dollars more to finance the same government spending.

Dan Alpert, managing partner of Westwood Capital and author of The Age of Oversupply: Overcoming the Greatest Challenge to the Global Economy, thinks that fears of investor flight from U.S. sovereign debt -- and fears of subsequent interest rate hikes -- are unfounded. He notes that debt payments make up a small share of the U.S. budget and argues that they can be prioritized without affecting investors’ faith in repayment. The Federal Reserve can print money to meet those obligations, as well, Alpert says.

“Everybody knows that the date is not really a hard date,” Alpert told The Huffington Post.

Alpert, who is also a fellow at the Century Foundation, a progressive think tank, argues that the greatest risk of failing to lift the debt ceiling before Nov. 3 is that it would reduce government spending, which would have an adverse effect on the economy. He predicts that missing the debt limit deadline would lead to a scenario like the 2013 federal government shutdown, when nonessential government services were shuttered. Since the U.S. economy relies on government demand for goods and services, every dollar that goes unspent would cost the country even more in lost economic activity. The 2013 shutdown, which lasted for five weeks, cost the country an estimated $24 billion in lost economic activity, according to Standard & Poor's.

Another event like that “will hit the markets and the working man who depends on that spending to keep money flowing into his paycheck directly or indirectly,” Alpert predicted.

House Speaker John Boehner (R-Ohio) will bring a bill increasing the debt limit this week with budget reforms favored by
House Speaker John Boehner (R-Ohio) will bring a bill increasing the debt limit this week with budget reforms favored by conservatives, which President Obama has vowed to veto.

The best-case scenario

The best and most likely scenario is that Congress averts default by raising the debt limit at the last minute -- or at most, a couple days after the Nov. 3 deadline. If all goes well, Treasury would prioritize payments to holders of public debt for the brief period after the deadline, and investors would (hopefully) not punish the U.S. too severely for coming so close to default once again. 

The Treasury Department has said it would technically be possible to prioritize principal and interest payments to U.S. creditors over payments to federal government agencies and beneficiaries. That means the U.S. government could pay private and sovereign holders of U.S. debt -- including the government of China -- on time.  

Other government payments -- like cash benefits for veterans and Social Security recipients, and paychecks for active-duty military service members -- would be delayed until they could be made in full.

“We have been down this road before,” said Diane Swonk, chief economist at Mesirow Financial, in an email to HuffPost. “Markets are clearly calling Congress’ bluff and betting against an all-out default on our debt obligations.”

After the near miss in 2011, Standard & Poor’s credit rating agency downgraded the United States' credit rating from AAA, the highest possible rating, to AA+, where it remains. The Government Accountability Office estimates that the 2011 showdown raised the country's borrowing costs by $1.3 billion in fiscal 2011.

It's not clear whether the U.S. will face another downgrade if Congress acts before Nov. 3. Global investors are used to congressional dysfunction by now, so the game of chicken currently happening in Washington likely doesn't worry them as much as it might have a few years ago. They have faith that U.S. lawmakers will take action before it is too late -- just as they did in 2011 and 2013. 

“The world has adjusted downward to the fact that we have trouble keeping our act together,” Truman said. “They are used to this happening.”

Even prioritizing payment to lenders after Nov. 3, when the government runs out of money to make other payments on time, will likely not be cataclysmic so long as there is a resolution in sight.

Investor confidence that the situation will return to normal is key.

Traders on the floor of the New York Stock Exchange. It is unclear how markets will react if the U.S. does not lift the debt
Traders on the floor of the New York Stock Exchange. It is unclear how markets will react if the U.S. does not lift the debt limit before Nov. 3.

The worst-case scenario 

On the other hand, things could go badly if holders of U.S. debt lose confidence that they are going to be repaid and begin selling their Treasury bonds. The value of U.S. debt would decline as supply exceeded demand. Investors would begin seeking higher interest payments to compensate for the added risk. The U.S. government would require more taxpayer money to fund the same programs.

Businesses and other institutions, which often rely on Treasury bonds as collateral to secure loans from banks, might begin to find it more difficult to afford credit.

It's not clear how long it would take for this cycle to begin playing out in earnest. But “you would probably be in serious trouble if it was more than a few days,” Truman said.

Over time, the government’s arrears would build up, creating a significant backlog. Payment delays would grow exponentially as a result.

Demand for U.S. debt remains consistently high in part because it is repaid in dollars, which investors trust to retain their value relative to other currencies, due to the stability of the United States' government and economy. Oil, for example, is traded in dollars on the global market.  

If demand for U.S. debt were to decline because of concerns about repayment, the value of the dollar relative to other currencies would drop as well. The dollar would risk losing its status as the reserve currency of choice, further reducing demand, driving down value and increasing the cost of borrowing. The price of imported goods that U.S. consumers depend on could also skyrocket due to an excessive decline in the dollar’s value.

“It is a slippery slope, and it is hard to anticipate how steep that is,” Truman said. 

At the same time, a downturn in government spending would have a depressing effect on the economy. For certain groups of people, like seniors and disabled veterans, this would be especially dangerous, since many of them depend on cash payments from the government to survive.

House Republicans passed a bill on Wednesday allowing the government to issue new debt solely for the purposes of paying the principal and interest on debt held by the public, as well as the principal and interest on debt held by the Social Security trust funds.

But Treasury says that even if it wanted to do so, prioritizing Social Security payments or funding for any particular government agency might exceed its technological capabilities. 

“Attempting to manually prioritize among more than 80 million payments made by the federal government each month -- to troops, veterans, Social Security recipients, Medicare recipients, vendors, etc. -- would be uncharted territory that’s fraught with risk,” Daniel Watson, a Treasury spokesman, wrote in a blog post last week.

Failing to raise the debt limit could delay payments of government benefits for senior citizens and veterans.
Failing to raise the debt limit could delay payments of government benefits for senior citizens and veterans.

The way forward 

Although analysts disagree about the severity of the fallout from not raising the debt limit by Nov. 3, and the timeline of what would happen after that, few dispute that the current brinkmanship reflects poorly on the U.S. government.

Given the willingness of Republicans to leverage the debt ceiling in an effort to achieve policy goals, a logical solution would be to eliminate the ceiling altogether.

Eighty-four percent of economists surveyed by the University of Chicago Booth School of Business in 2013 said they agreed that “a separate debt ceiling that has to be increased periodically creates unneeded uncertainty and can potentially lead to worse fiscal outcomes.”  

The United States is one of a very small number of countries that requires its legislature to continually increase the amount of debt it can issue after already approving tax and spending levels. Denmark may be the only other country with a comparably developed economy that has a debt limit. But Denmark has yet to reach its limit -- which it established in the 1990s -- because lawmakers deliberately set it at a very high level.

“No one in the rest of the world understands how we can be so bizarre,” Truman said. “At some level I understand the politics, but it is really an embarrassment.”

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