Why is the Debt Ceiling Back in News — and Should You Care?

The U.S. government has reached the debt ceiling. This means that it will not be able pay its bills within the next few months unless Congress raises the debt limit. The U.S. Treasury is able to keep everything afloat for a very short time before it defaults on its obligations, which could lead to disaster at both the national and international levels. Congress has just reopened the clock for Congress to act.

What is the debt ceiling? Why should you care?

The United States government’s debt ceiling (also known as the debt limit) is the maximum amount it can borrow to meet its legal obligations. These obligations include funding for Social Security, Medicare and military salaries as well as interest on the national debt.

On Jan. 19, the United States reached its debt ceiling.

The government risks default if it reaches the debt ceiling. This would lead to a financial crisis. Congress has 20 times modified the debt limit since 2002 to avoid a debt crisis.

Last Dec. 16, 2021, the U.S. debt limit was raised to $31.4 trillion.

In 2011, the U.S. reached its debt ceiling for the first time. This resulted in a standoff among Democrats and Republicans that led to market chaos. Although default was avoided in a last-minute deal to increase the limit, the ripple effects on economy lasted months.

The Department of the Treasury has taken “extraordinary measures” to stop the United States from defaulting. These measures primarily affect retirement funds. These measures include:

1. 
   Redeeming and suspending new investments in retirement funds for government workers, including the Civil Service Retirement and Disability Fund (or CSRDF) and the Postal Service Retiree Health Benefits Fund (or Postal Fund).
   

2. 
   Suspended reinvestment in Government Securities Investment Fund, Federal Employees Retirement System Thriftsavings Plan, or G Fund
   

Janet Yellen, Treasury Secretary, urged Congress to raise or suspend the debt limit in a Jan. 13 email. She stated that the Treasury believes the government will run out money by June and be in default.

The majority of Congress agrees that increasing the debt limit and thereby repaying government debts is necessary and routinely votes in favor. This time, however, it will not be so simple.

According to reports, Republicans want cuts in future spending in return for an increase in the debt ceiling. Kevin McCarthy (R-Calif.), House Speaker, requested that negotiations begin. It is not common to negotiate in order raise the debt ceiling. Democrats won’t budge on their demand to increase the debt ceiling without strings. Karine Jean-Pierre, White House Press Secretary, stated at a press conference on Jan. 18 that “We have been very clear about this.” We will not be negotiating the debt ceiling .”

It could cause a financial crisis of Armageddon proportions in the U.S. and other global economies if the default continues for more than a few days.

In October 2021, the White House Council of Economic Advisors warned of possible consequences of the U.S. defaulting. These include a global recession, worldwide freeze credit markets, plunging stock market and mass layoffs. The GDP (real gross domestic product) could also drop to levels not seen since before the Great Recession.

The U.S. has defaulted only once in its history, in 1979. This was due to a technical glitch that delayed certain U.S. Treasury bondholders’ payments. It was only a small number of investors that were affected by the whole thing, and it was resolved within weeks.

The 1979 default was not an accident. Global markets see a huge difference between an administrative hiccup and a full-blown default due to Congress’ failure to increase the debt limit.

Two possible stages could lead to a default. The government could delay paying Social Security recipients or federal employees. The government might not be able to pay its debts or interest to its bondholders. U.S. debt can be sold to investors as bonds or securities to corporations, private investors, and other governments. Market turmoil would be caused by the threat of default: There will be a big drop in demand for U.S. bonds if its credit rating is lower and it is sold. This will then lead to a rise in interest rates. To justify the higher risk of holding and buying its debt, the U.S. government will need to promise higher interest payments.

These are some other things you might see if the U.S. defaults.

The U.S. government is considered one of the most stable and safest securities in the world. A default could lead to a sell-off of U.S. debt. A sell-off in U.S. Treasurys could have devastating repercussions.

Money market funds, which are low-risk mutual funds, invest in high-credit, short-term debts such as U.S. Treasury Bills. These funds are popular among conservative investors because they provide protection against volatility and are more resistant to changes in interest rates.

Investors have sold money market funds in the past when the U.S. exceeded its debt ceiling and signaled a possible default. The yields on shorter-term Tbills are higher because they are more affected than longer-term bonds. This gives investors more time to calm down.

Federal benefits could be suspended or delayed in the event of default. These include:

Social Security, Medicare and Medicaid, Supplemental Nutrition Assistance Program (or SNAP) benefits, housing assistance, and assistance for veterans.

A default could trigger a downgrade in the United States’ credit rating. The S&P has only once previously downgraded the country’s credit rating, in 2011, when the country was close to default. According to the White House Council of Economic Advisors, a default and a downgraded credit rating will cause markets to crash.

Markets could become more volatile if the current debt ceiling talks are continued for too long.

Americans may see interest rates rise on consumer loans products such as credit cards and variable-rate student loans, as long as debt ceiling negotiations continue.

Credit lenders might have less capital or tighten their standards which could make it harder to obtain credit.

Rates on new auto loans, federal and private student loans, and personal loans could rise depending on when a default occurs and how long it takes to feel the effects.

Tax filers who file after the debt ceiling has been raised could be delayed in receiving their refunds. Usually, they receive them within 21 days. Late filers run the risk of missing their refunds if the government defaults.

Fixed-rate mortgages and fixed-rate home equity loans of credit (HELOCs) won’t be affected by a debt ceiling crisis. Adjustable-rate mortgage (ARM) holders could see rates rise more than they have already — up to four percentage points on the rate indexes from spring 2022. Rates will rise for those who have an ARM that is within their fixed term.

Rates on new mortgages will likely rise if the government defaults. However, it is not clear in which direction variable rate HELOCs will move

Although the debt ceiling and national debt are not the same, they do relate. The debt ceiling refers to the maximum amount the government can borrow before defaulting. The total federal debt, $31.41 trillion at Jan. 19, is the amount of money borrowed by the federal government plus interest. Refusing to vote for the debt ceiling increase would not reduce the national debt. It would also mean that the government can’t repay its debt.

Here’s how the nation debt works: A budget deficit is when spending exceeds revenue during a fiscal year. To pay the deficit, federal government borrows money through the sale of marketable securities. These securities include Treasury bonds, Treasury notes, floating rate notes, Treasury bills and Treasury inflation-protected Securities (or TIPS). The total amount of debt includes the amount borrowed and the interest it promises to the people who lent money to purchase those marketable securities.