Debt Ceiling: Is the US Government Still Threatened by a Downgrade?

In an article on thestreet.com, Robert Holmes tells the story of Jeffrey Sica, a money manager, and his politically unpopular view that Standard and Poor, the ratings agency, should make good on its threat to downgrade US paper, despite the debt ceiling deal reached today. This move would be nothing short of necessary for the ratings agency to retain its credibility, especially after a dismal track record of rating dangerous securities triple-A during the pre-recession MBS bubble. This statement resonantes with many Americans still frustrated with the trajectory of federal spending, many noting that no individual or corporation could possibly maintain access to cheap capital with anything close to the spending/revenue ratio we are currently seeing. While S&P has not yet issued a statement regarding this latest debt deal, the markets have reflected the continuing uncertainty felt by many regarding the recent revisions of the first quarter's GDP, and well as recalculations of inflation and manufacturing outputs. Treasury rates are also up, indicating bond investors are not yet willing to embrace "mission accomplished" on the debt problems plaguing the government. Could we be witnessing the decline of modern Keynesian Economics?

Gof6 Budget Plan: Will it Help Raise the Debt Ceiling?

For some reason, the answer appears to be, no. Surprisingly enough, the criticisms regarding the plan drafted by the "Gang of Six" and its inclusion into debt ceiling negotiations came from both sides of the aisle. House republicans have already begun to critique the plan because of inclusion of "tax hikes" in the plan. Senate Democrats have been cited saying the proposal comes too late to be included in the debt ceiling negotiations.

Despite what is being said, it does not appear that any new taxes are included in the proposal. While 26% of the dollar total of the bill comes from "revenue", as I read it, the proposed money comes from closing tax loopholes and streamlining the confusing tax codes. While this will generate up to $1 trillion in revenue over the next ten years, the technical data reveals an actual "$1.5 trillion tax cut".

While this is a leap in the direction of austerity that America desperately needs, the implementation of any plan resembling this one is likely not to be even discussed in Congress until August 3rd (assuming the debt ceiling is raised).

Public Confusion: The Debt Ceiling

With the August 2nd deadline just 18 days away, I awoke to yet more disappointing news regarding the impasse of a debt ceiling resolution. I personally cannot imagine how anyone would use the well being of our national economy as a bargaining chip. As an article in The Economist put it, our politicians are not even in agreement that hitting the debt ceiling would be catastrophic, let alone in agreement over how to raise it. All this despite testimony from Federal Reserve Chairman Bernanke stating that even a technical government default would be calamitous.

Perhaps even more striking is a recent Gallup Poll revealing that less than one quarter of Americans actually favor raising the debt ceiling. I can only hope these numbers reveal a lack of understanding regarding the terms "debt ceiling" and "technical default", rather than a genuine desire to force our government to decide between paying our soldiers or our doctors, not to mention the tail risk in the bond market. So, for the sake of clarity for all five of my readers, let us discuss the definitions and implications of these terms:

The debt ceiling is the result of a rather quirky law that caps the amount of money the government can borrow to cover expenses. We, as in the government, spends much more than we take in via taxes, so we borrow money to cover the difference. One must remember that we are the only "first world" country in the world that has a debt ceiling at all, but we are one of many that operates on a continuing budget defecate.

Perhaps the confusion regarding the debt ceiling is a misconception that raising the debt ceiling somehow authorizes new spending programs. This is not the case. The debate on where money goes is the business of Appropriations Committees. The raising the debt ceiling would do little more than allow the government to cover its current bills, such as Social Security and the salaries of public workers.

The term "technical default" is also a common source of confusion. Many Americans seem to believe that America, if a debt ceiling agreement is not reached in time, can simply pay off its bond debt obligations with money cut from entitlement programs that would be cut. While the likelihood of the Treasury Department putting foreign banks in line ahead of Medicare beneficiaries is questionable at best, the simple fact that we are in financial trouble at all would constitute a technical default; the primary ramification of which would be a hike in rates demanded by bond holders for acquiring the added risk of holding paper of a country in trouble. Therefore the total debt of the government to bond holders would actually be higher under a debt ceiling impasse than there would be otherwise.

So despite widespread panic and confusion, the numbers (the only real facts in this debate) indicate the need for an increase in the debt ceiling. The long overdue discussion regarding spending, taxes, and entitlement programs is better suited for the campaign trail and the budget committees.

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.