The Congressional gridlock that we have become accustomed led to yet another government shutdown for 16 days. In the 11th hour, an agreement was reached that briefly diverted disaster. The debt cushion now extends through Feb. 7, with current spending levels being authorized through Jan. 15.
That means a few months of breathing room, but little more. After all, the bill doesn’t address many of the contentious and complicated issues — from changes to entitlement programs to tax reform — that continue to divide Democrats and Republicans. In my mind, though the shutdown will end up costing anywhere from $12 to $24 billion (depending on whose estimate you read), the bigger issue was not defaulting on our national obligations.
The U.S. Treasury Department says that failure to raise the borrowing limit could trigger a default, which would lead to “a financial crisis and recession that could echo the events of 2008 or worse.”
So let’s take a minute to describe exactly what the debt ceiling is, why we even have one and whether disaster would really occur if Congress doesn’t lift it by Feb. 7 next year.
Debt Ceiling Explained
When Congress approves more spending than the revenue it generates through taxes, the Treasury has to borrow the rest to meet those financial obligations. But Congress has always imposed a legal limit on how much money the U.S. Treasury can actually borrow from outsiders and other government accounts.
That limit is called the “debt ceiling” and it currently sits at $16.699 trillion. The debt ceiling only determines whether the U.S. government can borrow enough money to fulfill obligations that Congress has already passed into law such as Medicare reimbursements or military pay. The Treasury Department can borrow that much and no more unless Congress votes to raise the ceiling.
What most folks don’t realize is that the U.S. government actually hit its $16.699 trillion borrowing limit back on May 19. Since then, the Treasury Department has taken a slew of “extraordinary measures” to raise an extra $303 billion and ensure the government has enough cash to meet all its obligations.
By Oct. 17, however, the Treasury Department would have run out of “extraordinary measures.” The government no longer would have had enough cash on hand to meet all of its coming financial obligations, and be able to borrow or scrounge up any more money. The Bipartisan Policy Center report estimates that Congress would need to raise the debt ceiling by around $1.1 trillion to allow the government to meet all of its obligations through the end of 2014.
Each and every day, computers at the Treasury Department receive more than 2 million invoices from various agencies. The Treasury computers make sure the figures are correct and then authorize the payment. This is all done automatically, dozens of times per second. According to the Treasury Department’s inspector general, the computers are designed to “make each payment in the order it comes due.” So if the money isn’t there, the defaults could be random. Maybe a payment to a defense contractor comes up short. Maybe a Social Security check bounces. Maybe an interest payment to bondholders fails. No one knows.
A prolonged breach of the debt ceiling could result in a massive dose of fiscal austerity, putting an additional dent in the moderate economic growth we are experiencing. A default on the debt would almost certainly create disruptions in the financial markets.
Remember, if Congress refuses to lift the debt ceiling, the federal government can only pay out as much as it takes in taxes. Goldman Sachs estimates the spending cuts would come to about 4.2 percent of GDP — a much sharper drop than the previous sequestration budget cuts or the furloughs caused by the government shutdown.
The financial response is harder to forecast, especially if prioritization is impossible. The Treasury Department certainly thinks the prospect of missing a debt payment could be ruinous: “Credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.” Similarly, a recent analysis by Deutsche Bank estimated that the U.S. stock market could lose 45 percent of its value if the U.S. government missed an interest payment.
Not the First Time
Bear in mind that this is NOT the first time we have covered this ground. Since 1960, Congress has raised the debt ceiling 78 times. So why has raising the debt ceiling been so contentious lately? It all started back in 2010. Republicans had just won a huge victory in the mid-term elections, and Congress agreed during the lame-duck session to extend $850 billion worth of tax cuts. But Democrats, who still ran Congress at the time, didn’t include a debt-ceiling hike in the deal.
So, in 2011, when it came time to raise the debt ceiling, Republicans refused to do so unless they received significant spending cuts in return. The negotiations dragged on for much of the summer of 2011, and the financial markets got the jitters. Eventually, Republicans and the White House struck a deal. Congress would raise the debt ceiling by $2.4 trillion (to its current level). At the same time, lawmakers would enact $2.1 trillion in deficit reduction — a deal that eventually lead to the sequestration budget cuts.
The real out-of-the-box question is whether a debt ceiling is even needed. Back when the debt ceiling was first adopted in 1917, it was arguably a useful device for Congress to prevent the president from spending however much he wanted. But since 1974, Congress has created a formal budget process to control spending levels. As such, many observers don’t see why there’s a need for Congress to separately authorize borrowing for spending that Congress has already approved, especially when a failure to lift the debt ceiling would be so devastating.
It’s worth noting that there’s nothing about debt ceilings in the U.S. Constitution and most modern democracies seem to do just fine without explicit borrowing limits, including Britain, Canada, Germany, Japan, Australia and France. For what it’s worth, there’s a long list of experts who think the United States should just abolish its debt ceiling altogether.
In a January survey of academic economists by the University of Chicago, 84 percent agreed that having a debt ceiling “creates unneeded uncertainty and can potentially lead to worse financial outcomes.” But no one listened, so here we are...again.
After the government shut down for 16 days in October, lawmakers now have a few months of breathing room to try to figure out what the debt ceiling really needs to be.