The debt ceiling is imposed by Congress to limit the amount of debt the federal government can have outstanding. It is important to note that this is not for future expenditures but to cover spending that has already occurred. If the limit is exceeded, the government is unable to continue borrowing to pay its bills. To prevent default, the Treasury Secretary is authorized to use ‘extraordinary measures’ which keeps the government running for a short period of time but does not resolve the problem. To date, every time we have gotten close to default, we have either suspended or raised the debt limit, including eight times in the past decade.
Prior to World War I, Congress tightly controlled debt through individual pieces of legislation. As the war progressed, this ad hoc method became increasingly complex leading to the establishment of a debt ceiling on bond issuance in 1917 and eventually a consolidation of other government debt into the first aggregate debt limit in 1939. Giving control to the Treasury provided more efficiency and flexibility while also, in theory, putting restrictions on the total amount that could be borrowed. However, the debt ceiling has been modified over 100 times.
Budgeting conflicts have occurred for decades. Even with several attempts to pass legislation addressing the problems, the fighting has only gotten worse. The inability to resolve these conflicts has helped create the environment we see today, where the debt limit is used as leverage for future budgeting priorities and political gain. To inform how this may impact you today, it is key to look back at the effects of recent political brinksmanship.
In 2011, default was narrowly avoided when an agreement was reached just days before the deadline, but negotiating right up to the wire did have economic consequences. The country’s credit rating was downgraded for the first time in history, leading to additional borrowing costs estimated at $1.3 billion and a bear market decline of over 21% on the S&P 500 from May to October. However, the decline was short-lived, and the stock market quickly rebounded to end the year flat.
In 2013, the government shut down from October 1st until October 17th before the debt limit was ultimately raised. This led to higher short-term interest rates and increased borrowing costs for both the government and individuals. While there was a small -1.5% decline in the middle of the shutdown, over those 16 days, the S&P 500 rose over 3% and was up over 6% just three months after. This time the individual impact was much greater – the shutdown delayed the pay of approximately 850,000 federal employees who were furloughed and indirectly impacted millions of others.
While the past does not guarantee future outcomes, if you are invested with a long-term mindset and have enough cash on hand, you will be in a position to ride through any short-term turbulence as the current debt ceiling debate heats up. If you would like to schedule time with an Advisor to discuss anything specific to your unique situation or long-term financial goals, please reach out.