Recent and Upcoming Debt Ceiling Debate

How This Affects the Economy and Your Investment Portfolio

Recent and Upcoming Debt Ceiling Debate
January 30, 2017

The increasingly common Congressional battles over raising America's debt ceiling -- the maximum amount of money the Treasury can borrow -- leave many people confused and concerned. For the rest of the world, the concept of voting on whether or not to pay bills you've already incurred seems bizarre. For Americans, it reflects the deep divide in our country regarding acceptable debt levels. The average American has trouble putting debt numbers in a fiscal perspective – but markets do not. How, then, have the markets reacted to this rolling Congressional game of chicken?

Let's begin with the debt ceiling crisis of 2011. As the summer approached, Republicans in the House of Representatives demanded that the President agree to further deficit reduction measures as the price for increasing the debt ceiling. Historically, such increases were considered a formality, as Congress itself approves the underlying spending. (There were, in fact, 74 routine debt ceiling increases since 1962.) But the 2010 Congressional elections sent a wave of “Tea Party” conservatives to Washington, and these new hardline Members had little regard for either political convention or the Democratic President. Consequently, they attempted to hold the gun of fiscal default to his head. The President blinked, and agreed to a set of complex spending reductions two days before a possible US government default, which would have been the first in our nation’s history.

The financial markets did not look at all kindly at this brinksmanship. According to the Treasury Department, consumer confidence fell 22% from June to August 2011, taking six months to recover. The S&P 500 index fell 17% in that period and took more than six months to recover. Mortgage spreads followed a similar curve. The Treasury Department estimated a $2.4 trillion loss in household wealth, and $800 billion in retirement assets alone. And most striking of all from a psychological standpoint, the credit rating of the United States was downgraded for the first time in history by Standard & Poor’s. While not all of this fiscal bleeding can be attributed to the debt ceiling crisis, most experts assign to it the lion’s share of blame.

Moving forward to 2013, Congress introduced the so-called "fiscal cliff" provisions. While "Fiscal Cliff" may sound like the name of a Rastafarian economist, it actually refers to the summary effects of sequestration cuts in government spending and other measures designed to make Congress act on spending and the debt ceiling. In essence, Congress put a gun to its own head this time -- either we make a big deficit reduction deal, or across-the-board cuts no one wants will be enacted. However, once again Congress overestimated itself.

Sequestration took effect, and we found ourselves in another debt ceiling debate in October 2013. However, the economic effect this time doesn't seem to have been as severe. Standard and Poor's estimated that uncertainty fueled by the 2013 debt ceiling debate removed $24 billion from the economy (approximately 0.6% of 4th quarter GDP). The S&P 500 took a temporary dip around the signing date, but recovered quickly. Consumer confidence took a smaller hit as well. Perhaps the markets are becoming accustomed to last-minute Congressional escapes (even with some in Congress openly stating that default may not be such a terrible thing).

So what comes next? Keep in mind that the October 2013 deal (the “McConnell Rule”) didn't actually raise the debt ceiling – it merely suspended it through February 7th, 2014. On February 8th, however, the debt ceiling renews at the previous $16.7 trillion level. If the McConnell Rule were adopted permanently, the debt ceiling would be effectively eliminated. But the chances of that happening are about the same as flying pigs circling the Capitol.

As in past crises, the Treasury department can use "extraordinary measures" to extend the debt, which is the governmental equivalent of looking for cash in the couch cushions. This is likely to last until March, when the debt ceiling will need to be raised again to avoid default. A debt ceiling increase of $1.1 trillion is expected to get America through 2014. Most analysts expect some sort of last-minute compromise or typical kicking of the can down the road. It is reasonable for investors to expect a short-term drop in stock prices during this debate, recovering quickly enough once a deal is reached.

The remaining question, however, is this: Can our national leaders put the long term stability and welfare of the American economy – and people – ahead of their partisan warfare? If so, these episodes of self-inflicted economic harm may finally disappear in the national rear view mirror. But our view of such a miraculous occurrence will probably be blocked by flying pigs!

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