Today's Headlines: How Does the Debt Ceiling Affect You?

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Today's Headlines: How Does the Debt Ceiling Affect You?
August 29, 2017

Yet Another Crisis

Every day in Washington, D.C., seems to bring new crises to defuse. One of the next ones on the list is the upcoming need to raise the debt ceiling before the government runs out of money to pay the nation's bills. Without action, the government is anticipated to run out of money in early October.

Once again, one group is asking for clean legislation to raise the debt ceiling, while others threaten to use the debt ceiling bill as leverage to promote other legislative goals. The novel twist this time is that Republicans are fighting other Republicans.

At first glance, this may seem like more partisan Washington nonsense that doesn't affect you personally. The partisan and nonsense part may be correct, depending on your political leanings – but the effects of a failure to raise the debt ceiling can lead all the way to your pocketbook.

Who Gets Left Out?

Keep in mind that raising the debt ceiling does not authorize the government to spend more money – it authorizes the government to deal with debt it has already accumulated (i.e., that Congress previously authorized).

Think of sitting around your kitchen table, deciding which bills to pay with the money you have available. If you have a surplus, there's no problem. If you have a deficit, you must decide which bill gets put off or eliminated – say missing the cable TV bill for a month, or cancelling it entirely – or you borrow money to pay off current bills in exchange for interest payments down the road.

This may be a simplistic example, but it effectively outlines the task of Treasury Secretary Steven Mnuchin. "Congress says you can't borrow any more money, and incoming cash flows are insufficient and unpredictable. Shortly, we will run out of cash. Which obligations are you going to pay?"

This is where you come in. Almost everyone will be affected in some fashion, because the government makes all sorts of payments to American people and businesses every day. Consider Social Security and welfare recipients, bondholders, tax refunds, companies that do business with the government (thus potentially affecting your paycheck if you work there) – somebody isn't getting paid, or could potentially get paid less than the full amount owed. Do you get paid, or do you get left out?

Uncertainty Rules

In addition to direct effects, there will be ripple effects throughout the economy based on new levels of uncertainty. Congress and the executive branch have engaged in the debt ceiling fight regularly in recent times, and they always back down before default occurs. However, even the threat of default is enough to cause tangible problems.

During debt ceiling showdowns in 2011 and 2013, U.S. short-term bond yields spiked simply by raising the possibility that the U.S. may not meet fiscal obligations. According to the Federal Reserve, those spikes cost the U.S. millions of dollars in interest charges to borrow necessary funds – adding more to the debt burdens that will fall to our children and grandchildren.

Should the debt ceiling not be raised by the time default occurs, markets will take a very different approach. We will have seriously dented the world's trust in America's ability to fulfill fiscal obligations, and that trust would take years to repair – if it can be repaired at all. The U.S. would certainly lose its coveted AAA bond rating, and it will cost more for the U.S. to borrow money for the foreseeable future. Stocks will likely suffer as well.

What about mortgage rates and credit cards? During previous showdowns, interest rates were not drastically affected, based on the assumption that a deal would be reached as always. However, if we cross the threshold of default, you can apply the principle that "higher risk means higher rates."

Lenders will be hit from all sides – consumers will feel at least some of the ripple effects, and spooked investors will hamper a lender's ability to resell debt to the secondary market. Credit card issuers will be wary of economic slowdowns causing higher default rates within their customer base, and rates would likely rise as a result. If you want more credit, check out MoneyTips' list of credit card offers.

Eventually, we would hit a new equilibrium as lenders adjust rates as needed to maintain business. However, that equilibrium point will almost certainly not be favorable to consumers or to the health of the broader economy.

The Takeaway

In the end, the federal government is likely to raise the debt ceiling and avoid the above scenarios – although any predictions involving President Trump's administration are dangerous. Most precautions that you can take are common sense moves that you should be undertaking in any case. (Perhaps the government should give them a try as well.)

Make a budget that encourages saving instead of spending, and stick to that budget. Use savings to build an emergency fund for events that can temporarily take a bite out of your income – such as a potential failure to raise the debt ceiling causing the government to run out of money.

Set your own "debt ceiling" as part of your budget that accommodates useful debt such as equity-building mortgage loans and minimizes high-interest credit card debt. Manage your debts and cash flow to avoid paying interest wherever possible, and keep your credit score high to get the best deal on interest rates on those occasions where you do accrue interest charges. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.

In short, be better than our government when it comes to finances. You may not be able to drain the swamp in Washington, but you can prevent the formation of a fiscal swamp in your own household.

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Barry Rabinowitz
Financial Adviser in Plantation, FL | 08.30.17 @ 11:25
Nobody can predict what the Congress will do. It should not affect any financial decisions or your long term financial plans
$commenter.renderDisplayableName() | 11.28.20 @ 10:23