Logo Background RSS


Disasterous Consequences Of Not Raising Debt Ceiling

  • Written by Syndicated Publisher No Comments Comments
    January 17, 2013

    As we face another brutal fight over the federal debt ceiling at a time when the economy still remains fragile, the stock market is oddly complacent. Even if the debt ceiling crisis is resolved, the result would be some combination of spending cuts and tax increases that would weaken the economy in 2013. A settlement, however, is far from a done deal as both sides remain far apart and determined to defend their positions. Far worse, if the debt limit is not raised or eliminated, the effect on the economy and markets could be disastrous.

    Republicans are insisting on major spending cuts in exchange for raising the debt limit while President Obama is adamant in saying that he will not negotiate on that basis. A number of Republicans have voiced the opinion that government shut-downs have occurred in the past without any great consequences, and that we can do it again. However, a failure to reach agreement this time would involve not only a shut-down, but a failure to pay many billions of dollars of U.S. government obligations, something that has never happened before in the U.S. On the other hand, it is not clear how Obama can avoid negotiations over the debt limit, as other proposals floating around appear to be unfeasible or unconstitutional.

    This week the Bipartisan Policy Center issued a 41-page report detailing the disastrous consequences of not raising the debt limit. We outline the report as follows. The full report can be found at www.bipartisanpolicy.org.

    The U.S. government hit its debt limit on January 1st. The Treasury secretary then tapped into the $201 billion emergency borrowing authority to allow for an additional period of fully-funded government operations. It is estimated that the emergency funds will run out sometime between February 15th and March 1st. After that, the government can pay out only what it receives in revenues, which covers only about 60% of the obligations due between February 15th and March 15th.

    The Treasury then has two choices as to how to make the payments. It can make all of each day’s payments once enough cash is available. In this case all payments would be late, and they would get later and later with the passage of time. An exception could be made for interest payments on the debt so that no default actually occurs.

    The second choice would be to pay some bills on time while others would not be paid. It is unclear whether this method is legal or even feasible, given the design of the Treasury’s computer system. The department makes about 100 million individual payments monthly, and would be forced to pick and choose which ones to make and which to skip.

    The problem is that the monthly cash inflow would be roughly $277 billion and the obligations at $452 billion, leaving $175 billion unpaid. Let’s suppose that Treasury chooses to pay interest on Treasury securities, IRS tax refunds, Medicare and Medicaid, Social Security benefits, military pay and retirement, and unemployment insurance benefits.

    That would eat up all of the cash flow leaving the following items unfunded: defense vendor payments, veterans’ benefits, federal salaries and benefits, Pell grants and special ed. programs, food and nutrition services, civil service retirement payments, health and human services grants, supplemental social security income, the Department of Justice, the FBI, the federal courts, the Department of Energy, the Federal Highway Administration, the FAA (air traffic control), the Environmental Protection Agency, FEMA and the National Flood Insurance Program. These payments and non-payments can be calculated in other combinations, but the point is that about $175 billion of obligations can’t be funded.

    The disastrous consequences of not increasing the debt limit are easy to see. It amounts to a sudden 39% decrease in government spending, resulting in severe recession, plunging global markets, rating agency downgrades, widespread uncertainty and public unrest. Moreover, the damage to the credit rating of the U.S. would lead to far higher interest payments for years to come.

    In our view the stock market is not discounting either the disastrous consequences of not raising the debt limit or the still negative growth impact of additional spending cuts and tax increases. The S&P 500 is near a 5-year high while the VIX volatility index is at its lowest point since May 2007. All in all, it is similar to the conditions in early 2000, when the market ignored the vulnerability of the dot.com boom and late 2007, when the “experts” ignored the importance of falling home prices and record household debt. In both cases the S&P 500 plunged about 50%.

    Images: Flickr (licence attribution)


    About The Author

    Lance Roberts – Host of Streettalk Live

    lance robertsAfter having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.