Dissecting the Possible Outcomes of Hitting Debt Ceiling
In the fast-moving world of the debate over the federal debt ceiling (a phrase that I seriously doubt has been used very often in American history), it’s possible and perhaps even likely that, if it dealt on current events, this week’s Fiscal Fitness would be out of date before it appeared in print.
For that reason it makes more sense to gaze just slightly into the future — to Aug. 2 — when, depending on whom you believe, either all economic hell will break loose and financial thunderbolts will be hurled from the heavens or we’ll have the fiscal version of Y2K and Aug. 3 will be just another day in the life of the American economy.
Let’s start with the most basic truth of all: No one on Wall Street or in Washington really knows what will happen if the debt ceiling isn’t raised by Aug. 2, the date the Treasury says the government will run out of all but the most extreme, embarrassing, untried and not-necessarily-legal cash management options to borrowing.
There’s no doubt that on a day-to-day basis, Treasury won’t have enough cash to pay all the bills that are due because the revenues collected at any given time won’t always match the expenses that are supposed to be paid that day.
Beyond that, there’s little agreement on how it will play out.
Part of the reason for this lack of understanding is that the U.S. has never been in this position. We’ve had government shutdowns in the past and so have some experience with what happens. There are also memos from an attorney general and a director of the Office of Management and Budget that provide the equivalent of an operations manual on what to do and how to do it, or they at least serve as a guide to how it was done in the past.
But we have no similar experiences with what could happen on Aug. 2. And even if there were a precedent that could serve as a guide, the market changes on Wall Street and the political gyrations in Washington that have occurred in recent years make this year’s situation unique.
A financial disaster is the possibility that will have the fastest and most profound impact on the politics of the debt ceiling. I believe an obvious adverse market reaction might be the only thing that will provide a majority of Members with the incentive and political cover they need to vote for the increase in the debt ceiling they otherwise would prefer not to support.
A dramatically negative adverse market reaction would also change the politics of the debt ceiling because it would be the first time that voters would see and feel the impact of not increasing the government’s borrowing authority.
Until now, the predictions of higher interest rates and lower stock prices have been theoretical and, therefore, disputable. But something like the huge drop in the Dow Jones industrial average that occurred the day after the Troubled Asset Relief Program was voted down by the House in 2008 would do the same thing that happened then: Make it possible to pass otherwise unpassable legislation.
There will likely be other markers if the financial disaster scenario turns out to be correct involving interest rates (although there will be counter pressures that could keep them lower than some are predicting), the overnight lending between financial institutions that keep them compliant with capital requirements, the amount of lending by financial institutions, the ability of pension funds and others to buy and hold Treasuries and, of course, the federal government’s overall credit rating. The price of gold could soar beyond even the astronomical levels of recent weeks if investors flee from the previously assumed safe haven of U.S. bonds.
A negative market reaction won’t just affect investors or financial institutions. We learned in 2008 that big drops in the Dow and other major stock indices are widely reported by more than just the business channels because they often lead the evening local and national news. As a result, they are politically debilitating to those held responsible.
In many ways, no financial disaster would be more interesting. On the one hand, it would invalidate what virtually every current and recent financial policymaker, the major financial trade associations and many of the world’s most sophisticated investors have been saying for weeks. It would also make the preparations for a default by the Treasury, Federal Reserve and others involved in managing the government’s cash seem like a Chicken Little response.
More important: A very limited response or no response by the financial markets will remove all pressure by policymakers to do anything about the debt ceiling and, therefore, about the federal deficit.
This is one of the great ironies about the current debate. The Members of Congress who have been insisting that the reaction on Wall Street will be limited if the debt ceiling isn’t raised are also the ones who have been using it as leverage because of the implication that financial markets will not like it at all if nothing is done.
No immediate financial hardships from not raising the debt ceiling will also mean there will be new speculation about how long the situation can continue before it goes critical and the adverse market reaction that many had expected to occur actually materializes.
Assuming the delayed financial disaster hasn’t yet occurred, the next opportunity to use the legislative process to try to force budget changes will be Oct. 1, the date when the new fiscal year begins and the appropriations for fiscal 2011 expire. The threat at that point will change from “just” a federal default to a default and a government shutdown.
Stan Collender is a partner at Qorvis Communications and founder of the blog Capital Gains and Games. He is also the author of “The Guide to the Federal Budget.”