The Debt Ceiling: What Happens if We Don't "Raise da Roof"?

Never before have we had a problem raising the debt ceiling in America. However, due to the current political environment at home and fear stemming from the debt crises in the Euro-Zone, we now have a problem. While conceptually there should be no reason to think that we won't raise our debt limit on time (the 30 year Treasury note has been trending down as the ceiling limit nears), the rhetoric grows more fierce by the day. So what could we expect to see if the ceiling is not raised in time? According to an article in The Economist, it is difficult to say.

It is clear that once the government is out of money, the Treasury will go into default. However, exactly what that means is up for debate. Some believe that bond interest rates will be quickly adjusted and most of us will go about our marry way without notice. However, this is only true if the fallout period is relatively short and the ceiling is raised shortly after the technical default. As we can see from the technical default in 1979, even a momentary lapse in payment can cost us. The '79 default is largely considered to be the result of systems and bookkeeping errors, however it ended up costing the government millions.

Unlike in the late seventies, the domestic and global economy is more interconnected than ever. Banks all over the world hold T-Bills (around 30% of total collateral) in their vaults, the Repo market employs almost exclusively treasuries, and the interest rates set by the Federal Reserve work in tandem with bond interest rates. Even a momentary spike in rates would almost certainly freeze the already fragile credit markets and impact lending to businesses and individuals that rely on credit to survive.

However, there are a few "back-up" plans, including Senator McConnell's creative resolution to increase the debt ceiling in installments that are systematically proposed by the President, whereon the Republicans would offer a disapproval resolution, which would then be vetoed by the President, and protected from and override by the Democrats in Congress. While far from the textbook way of solving disputes in Washington, we may be seeing more and more of this kind of political maneuvering in the days to come.