A frequent topic in the news recently has been surrounding the U.S. Debt Ceiling, and the concerns that surround that. Below are some points from LPL Research that we think help provide some clarity around the uncertainty that has been going for the last few weeks.
U.S. DEBT CEILING QUESTIONS ANSWERED
1. What is the debt ceiling?
The debt ceiling is the limit on how much the federal government can borrow. Unlike every other
democratic country (except Denmark), a limit on borrowing is set by statute in the U.S., which
means Congress must raise the debt ceiling for additional borrowing to take place.
2. Why does the U.S. do it differently?
The debt ceiling was originally created to make borrowing easier by unifying a sprawling process
for issuing debt to help fund U.S. participation in World War I. The process was further
streamlined to help fund participation in World War II, creating the debt ceiling process that is in
use today. According to the Constitution, Congress is responsible for authorizing debt issuance,
but there are many potential mechanisms that could make the process smoother.
3. Why is it important to raise the debt ceiling?
The government uses a combination of revenue, mostly through taxes, and additional borrowing
to pay its current bills—including Social Security, Medicare, and military salaries—as well as the
interest and principal on outstanding debt. If the debt ceiling isn’t raised, the government will not
meet all its current obligations and could default.
4. Has Congress always raised the debt ceiling?
Yes, whenever needed. According to the Treasury, since 1960 Congress has raised the debt
ceiling in some form 78 times, 49 times under Republican presidents and 29 times under
Democratic presidents. Congress has regularly raised the debt ceiling as
needed. In fact, every president since Herbert Hoover has seen the debt ceiling raised or
suspended during their administration.
5. Is the debt ceiling being raised to cover potential new spending programs?
No. Lifting the debt ceiling does not authorize any new spending. The debt ceiling needs to be
raised to meet current obligations already authorized by Congress. Theoretically, not raising the
debt ceiling would limit spending in the future, but only by deeply undermining the basic ability of
the government to function, including funding the military, mailing out Social Security payments,
and making interest and principal payments on its current debt.
While perhaps symbolic of excessive spending, the debt ceiling is not the appropriate instrument
to limit spending. Spending responsibility sits with Congress and the president, but Democrats
and Republicans have both favored deficit-financed spending once in power. Bill Clinton’s
presidency, much of it with a Republican Congress, was the only one that saw the publicly held
national debt decline since Calvin Coolidge in the 1920s.
6. When was the debt ceiling last raised?
The debt ceiling was last raised in December 2021. No Republicans voted for that increase, but
some Republicans did vote to suspend the Senate filibuster so the increase could be passed with
a simple majority.
7. If we were at the debt ceiling on January 19 and nothing happened, why is there a
problem?
When we hit the debt ceiling, the Treasury is authorized to use “extraordinary measures” that
allow the government to continue to temporarily meet its obligations, including suspending
Treasury reinvestment in some retirement-related funds for government employees. But the
additional funding available through these measures is limited.
8. What’s the actual deadline?
The real deadline, also called the “x date” is hard to pinpoint because it depends on revenue
and payments that are variable as we approach the date. The level of tax revenue around the
federal income tax filing date is particularly important. The window right now is wide, probably
summer to early fall, but that does mean there are circumstances where the actual x date could
be early summer.
9. Who typically wins debt ceiling battles?
Independent of anyone’s view on the level of government spending, a timely increase in the debt
ceiling eliminates the risk of unnecessary turmoil for markets, businesses, and the economy. As
for who wins the battle politically, we leave that for voters to decide for themselves.
10. What would the Treasury have to do if Congress failed to act in time?
Without the ability to issue new debt to pay existing claims, the Treasury would have to rely on
current cash on hand (and incoming cash) to make its payments. So, the Treasury would be able
to make some payments—just not all of them. As such, the Treasury department would likely
have to prioritize its payments. Moreover, the longer the delay in raising/suspending the debt
ceiling, the harder it may be for Treasury to make its payments.
In 2011 and again in 2013, Federal Reserve and Treasury officials developed a plan in case the
debt ceiling wasn’t addressed in time. At that time, they determined the “best” course of action
would be to prioritize debt payments over payments to households, businesses, and state
governments. By prioritizing Treasury debt obligations it was assumed the financial repercussions
would be minimized. However, given comments by rating agencies (more on this below), there’s
no guarantee that prioritizing debt payments would stave off severe, longer-term consequences
like a debt downgrade or higher borrowing costs. Nonetheless, in order to adhere to the full faith
and credit clause within the Constitution, debt servicing costs would likely be prioritized.
There is the possibility that prioritizing debt service would be challenged in court. Even if there’s a
strong case to be made, we think debt service prioritization would be allowed to continue while
the case works its way through the courts, since the potential economic damage would be too
great otherwise. Even in the very unlikely event that Congress fails to raise the debt ceiling, the
political and economic fallout would potentially be so swift that we would expect it to be raised in
days rather than weeks or months, making the question of whether debt payments could be
prioritized a moot point.
11. U.S. Treasury debt was downgraded in August 2011 because Congress waited until
the last minute to raise the debt ceiling. Could we see additional rating changes this
time?
In 2011, even though Congress acted before the x date, one of the three main rating agencies,
S&P, downgraded U.S. Treasury debt one notch from AAA to AA+. While the other two main
rating agencies retained the U.S. AAA rating, they both downgraded the outlook to negative. S&P
has maintained that AA+ rating since 2011.
Now, all three rating agencies have publicly stated that they are confident a deal will get done.
However, one of the three, Fitch, has threatened to downgrade U.S. debt if the debt ceiling isn’t
raised or suspended in time. Further, Fitch has stated that prioritization of debt payments would
lead to non-payment or delayed payment of other obligations and “that would not be consistent
with an AAA rating.” So even if Treasury made debt payments on time, missing other payments
would likely result in a rating downgrade. It is likely other rating agencies would follow suit as well.
Another rating downgrade by a major rating agency would likely call into question use of Treasury
securities as risk-free assets, which would have major financial implications globally.
12. Could failure to address the debt ceiling push the economy into a recession?
It would depend on how long Treasury would have to prioritize payments. If the delay is only a
day or two, then it is unlikely the economy would slow enough to actually enter into a recession.
Payments that were deferred would be repaid in arrears so the economic impact would likely be
minimal.
However, in the very unlikely event that payment prioritization is necessary over a prolonged
period of time—say a month or longer—this could indeed cause economic activity to contract.
Since the government is running a fiscal deficit, and since Treasury cannot issue debt to cover
that deficit, spending cuts would need to take place. The spending cuts, if prolonged, would likely
push the U.S. economy into recession. Moreover, the unknown knock-on effects such as the
impact on business confidence would also likely slow economic growth. Since the situation would
be unprecedented, it’s very difficult to estimate the impact. Moody’s has said that based on their
modeling, “the economic downturn ensuing from a political impasse lasting even a few weeks
would be comparable to that suffered during the global financial crisis” (Moody’s Analytics, “Debt
Limit Brinksmanship,” 6).
13. How would a technical default impact the financial markets?
In 2011, the S&P 500 fell by over 16% in the span of 21 days due to the debt ceiling debate and
subsequent rating downgrade. The equity market ended the year roughly flat so investors who
were able to invest after that large drawdown were rewarded. However, that large drawdown was
due solely to the policy mistake of not raising the debt ceiling in a timely manner. It’s likely that if
Congress were to wait until the last minute in raising/suspending the debt ceiling, equity markets
would react similarly.
Perhaps counterintuitively, despite the prospects of delayed payments and the debt downgrade,
intermediate and longer-term Treasury yields fell/prices increased as they are generally
considered to be a “safe-haven” asset. And while that may have been the market reaction in
2011, there is no guarantee that in the event of a technical default and further rating downgrades
Treasury securities would have a positive return this time around, particularly if Treasury
securities lose their status as the risk-free rate.
We hope this information provides some clarity around the current news. If you have further questions, please do not hesitate to reach out to us at the office.
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This material is for general information only and is not intended to provide specific advice or recommendations for any
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