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Understanding The Debt Ceiling

Date: Tuesday, May 29, 2018 10:16 PM EDT

It is the responsibility of our Treasury Department to meet the government’s financial obligations. As most are aware, our current tax revenue does not cover those debts. In fact, since 1964 the US government has operated at a deficit. To bridge that gap and meet our obligations, the US government is forced to borrow money. It does so by issuing Treasury securities, namely Treasury-Bills, -Bonds and -Notes. In 1917 (during WW1), to curtail overspending, Congress instituted a debt ceiling which limited how much borrowing the Treasury Department could do through the issuance of these Treasury instruments. It is not uncommon for the US to hit that ceiling, which then requires congressional action to raise it or risk not being able to meet financial obligations. In fact, during the decade from 2000-2010 we hit and raised the ceiling ten times! 

This required intervention by our Congress has not always been smooth. For example, in early August of 2011 the political maneuverings by Congress almost resulted in US bankruptcy as the Treasury waited for them to raise the debt ceiling so they could issue the Treasuries necessary to pay interest or principal on maturing and outstanding treasuries to avoid going into default on them. It was literally a last minute, midnight compromise that raised the debt ceiling, thereby allowing the Treasury to meet its financial obligations.

Why do we have a debt ceiling?

Unfortunately, between that last week in July and the first week in August 2011, as the looming deadline approached, the Dow Jones Industrial Average lost over 2000 points, and on Monday, Aug 8, 2011 the Dow lost 635 points. It was also during this week that the ratings agency Standard & Poor’s downgraded US debt from AAA to AA+ with a negative outlook. Two other ratings agencies, Moody’s and Fitch, maintained a AAA rating for US Treasuries but did change their outlook to negative. We continue to hold those ratings today.

It falls to Congress to raise the debt ceiling or face defaulting on our debt. And though the U.S. continuously repeats this cycle of hitting and raising the debt ceiling, if US Treasury instruments should go into default, many institutional investors such as mutual funds, insurance companies, trust accounts and pension funds would be legally (fiduciarily) forced to liquidate their holdings in treasury securities. The resulting flood of securities sold into the market would result in a major deterioration of bond prices, and higher interest rates as a result.

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