Here we go again! It seems like just yesterday we watched this movie in 2011, the last time Congress went down to the wire to increase the debt ceiling limit. Similarly, today the GOP controls Congress and is looking for concessions on deficit and debt reduction measures from the Democrats in the White House before they agree to raise the debt ceiling. Thankfully, we haven’t seen a market decline or drop in our stellar U.S. Treasury bond credit rating. In August 2011, the stock market declined 10%, around the same time Standard & Poor’s lowered the government credit rating for the first time.
Our government established a debt ceiling in 1917 to limit the amount of debt the government could borrow to avoid financial problems. Unfortunately, our government seems to reach its limit every few years or so. This year’s ceiling is $31.4 trillion, equating to nearly the outstanding government debt. The Treasury Department says the government will run out of room to pay its bills around June 1. Without an increase to the limit, the government’s ability to pay interest on its debt, Social Security, Medicare benefits, salaries of Federal employees, military benefits, and more, could be in jeopardy.
It’s interesting to note the limit has increased 78 times since 1960. We suspect a 79thincrease, regardless of the outcome of these discussions in Washington. If not, thousands of people could suffer significant financial harm relying on government benefits and wages. However, the Treasury Department under Janet Yellen has “extraordinary measures” available if Congress fails to lift the debt limit. These extraordinary measures can include deferring payments, shifting federal monies to pay obligations, etc. Other measures include the Federal Reserve, which owns trillions in Treasury debt, temporarily forgoing principal and interest payments from the Treasury. This action alone could save the government billions in principal repayments and interest and keep it under the limit.
Nonetheless, even if these emergency measures occurred to avert default, they would no doubt spook financial markets and cause stocks to decline. The market doesn’t need more uncertainty at a time when it’s still digesting a 10th straight rate hike by the Fed, banking stress, and recessionary fears. Moreover, we don’t believe anyone, including our politicians, wants to see a default occur, even if it’s only temporary.
What Happens if the Government Defaults
If Congress doesn’t suspend or raise the debt limit, the Treasury would likely scale back its discretionary spending to help pay its obligations. In addition, credit rating agencies have already stated if the government missed one debt payment, they would lower our government’s debt rating. But, again, while this scenario is frightening, it also seems unlikely, given that a compromise has been reached numerous times in this situation since 1959.
As long-term investors, we’ve seen these debt ceiling fights before, with some coming down to the wire. We are confident this issue will be resolved, even if in the 11th hour or after. More importantly, we don’t believe this is a time to panic and change a prudent investment game plan. Of course, the media may run doom and gloom specials as we move closer to the deadline.
However, we know that overreacting to short-term events can disrupt long-term progress. Focusing on what we can control is critical, rather than things such as politics, tax policy, the economy, or uncertain market fluctuations. Investors can control their emotions, reactions, and investment allocations – this is what matters.
As Congress and the White House continue their high-wire act, we expect financial markets may be on edge as we head into June. You can be assured that our team is always available to meet or discuss any questions or concerns you might have.