Roughly a decade ago, investors were introduced to what was once an esoteric federal government process: the increase of the debt ceiling. The debt ceiling is simply the legislative limit on the amount of national debt outstanding in the United States, a dollar figure that historically was increased ad-hoc on a bipartisan basis. The implications of the debt ceiling are significant with a worst-case being the failure to raise the limit could result in a default on US government debt obligations, an event that would have untold repercussions in financial markets. In less severe outcomes, there are considerations for potentially higher borrowing costs, which also have significant economic implications.
Starting in late July 2011 a fierce debate raged over increasing the debt ceiling. The initial inability to pass an increase of the debt ceiling led to significant uncertainty in financial markets, with the US equity market falling over -15% and Standard & Poor’s downgrading the US Government credit rating to AA, the first such downgrade in the country’s history.
Source: Bloomberg LP and Wells Fargo Securities
Ultimately legislation to raise the debt ceiling was passed two days prior to the estimated default date, averting the worst-case scenario, leading to a recovery of equity and bond markets globally. The events of 2011 did set the stage for a lessor debate in 2013, but certainly raised the stature of this once-obscure legislation process for good.
While investors are certainly better prepared than 10-years ago, the political tension around the debt ceiling has come back in a strong fashion, with larger implications given the significant growth in outstanding federal debt. The timeline is quite tight – Congress returns from recess in mid-September, having to tackle the fact the government is set to shutdown on September 30th unless budget legislation can be passed. On top of a potential government shutdown, Treasury Secretary Janet Yellen warned in early September that the Treasury Department would likely run out of cash by the end of October if the debt ceiling is not raised.
Recent posturing has increased fears of a political game-of-chicken over the next two months. Congressional Democrats intentionally did not address the debt ceiling increase in their $3.5 trillion budget reconciliation package (presumably to maintain broader support for the legislation). On the opposite side of the aisle, 46 out of 50 Senate Republicans signed a letter pledging not to vote for a debt ceiling increase in any fashion, presumably to force Congressional Democrats to use the budget reconciliation process (which would not require any of the 50 Republican Senators). There are additional complications with the legislative ability to address the debt ceiling in this fashion.
The potential legislative saga is certainly better understood by investors today, in sharp contrast to 2011. The fact also remains that the US government has never defaulted on debt obligations and presumably the Democratic Party would not that break that trend while controlling Congress and the Presidency. Nonetheless, there is a potential for headline volatility as negotiations progress, which could result in attractive opportunities for long-term minded investors.