The debt limit—commonly called the debt ceiling—is the maximum amount of debt the Treasury Department is authorized to borrow to pay its already committed financial obligations. The amount is set through Congress and has been increased 78 times since 1960. Last raised by $2.5 trillion to $31.4 trillion in December 2021, the debt ceiling is back in focus as the ceiling was breached again on January 19. Treasury Secretary Janet Yellen, informed Congress that pending an increase to the debt ceiling, the department would have to enter into “extraordinary measures” to avoid defaulting on its obligations—essentially suspending reinvestments into certain programs and shuffling money around.
Yesterday, the Congressional Budget Office (CBO) released a statement projecting that the ability of these extraordinary measures to be effective would be exhausted between July and September of this year. If income tax receipts are lower than expected, for example if capital gains realizations in 2022 were less than CBO estimates, then the CBO stated the Treasury could actually run out of funds before July. Secretary Yellen previously noted the Treasury could fail to meet obligations in June.
We have seen standoffs over the debt ceiling play out in Washington many times before, but with razor thin majorities in both the House and Senate finding agreement may be particularly fraught. President Biden has said he will settle for nothing less than a no-strings attached increase, while House Republicans, concerned about overall levels of debt, have suggested they want a condition of raising the ceiling to be reductions in federal spending. As shown in the chart below, the total U.S. debt outstanding has almost doubled in the past 10 years and tripled in the last 15.
If the debt ceiling isn’t increased, the U.S. Government would technically default on its contractual obligations eventually. Once extraordinary measures were exhausted the Treasury would be forced to either undertake prioritization (making some payments not others) or to default on all debt (refusing to make any payments until it could make all), with the latter likely to cause more chaos for financial markets. Some more off-the-wall solutions floated around have included the Treasury minting a trillion dollar platinum coin, issuing debt with extremely high coupons, or through the Public Debt Clause found in the 14th Amendment, which some have interpreted to allow the Treasury to continue to issue debt to prevent default. However, the White House and Secretary Yellen have commented in the past that most of those options are not viable.
U.S. bond market investors have largely taken for granted the government’s ability and willingness to pay its debt. While its ability to repay its obligations is not in question, the debt ceiling debate complicates the country’s willingness to pay its debts. In 2011, Congress waited until the very last minute to fix the debt ceiling issues and S&P downgraded the country’s debt rating to AA+ from AAA because of the questions surrounding that willingness to pay its obligations. Another debt downgrade, much less an actual default, would likely be extremely disruptive to financial markets.
Our base case is still that Congress will act in time to either raise or suspend the debt ceiling; however, in the meantime, the closer the political brinksmanship allows the standoff get to the point of default, the more unnecessary volatility we are likely to see in markets.
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