Congress spent significant time in the closing months of 2021 dealing with an issue that it has confronted many times in the past – meeting its statutory requirement to raise the debt ceiling. Although this is a somewhat arcane procedure, it’s a required step to allow the U.S. Treasury to continue to issue debt to pay for federal government spending that has already been approved by Congress.
This was made clear in a recent commentary piece in The Wall Street Journal. Treasury Secretary Janet Yellen wrote, “raising the debt ceiling doesn’t authorize additional spending of taxpayer dollars. Instead, when we raise the debt ceiling, we’re effectively agreeing to raise the country’s credit card balance.”1
The need for such Congressional action has occurred nearly one hundred times since World War II. Most often, passage is a routine piece of business for legislators, but in some years, it becomes more of a political issue. The last time such a vote took place was in 2019, when Congress, in bipartisan fashion, lifted the limit on government debt.
However, the issue has confronted Congress for much of 2021. In December, both the U.S. House and Senate passed measures that gave the Senate more leeway in tackling the debt ceiling issue using a party line vote. That opened the door to a separate bill that would allow the debt ceiling to be increased and put the issue to rest for an extended period of time.
Why it matters
The federal debt is the total amount of money the government owes for spending on everything from Social Security and Medicare to defense programs and other types of domestic and overseas expenditures. The debt limit set by Congress represents the amount of funds that the U.S. Treasury is authorized to raise through debt security offerings to pay the operating costs of government.
In mid-October, Congress voted to extend the debt limit ceiling by nearly $500 billion, which met spending needs for another two months. Prior to that vote, the last authorization from Congress expired in July. In the interim, the U.S. Treasury Department used what are termed “extraordinary measures” to avoid running out of money. These steps included delaying deposits to government retirement accounts or to the Social Security Trust Fund.
Most expenditures that were delayed were for circumstances where the money was not specifically committed for payment at this time. “Necessary spending on natural disasters like Hurricane Ida forced the Treasury to spend some money that would have been relied on to extend the timeline for suspending the debt ceiling,” says Rob Haworth, senior investment strategy director at U.S. Bank. Time was running out on these measures allowing the government to continue to operate by the time Congress managed to pass the temporary measure to keep things running until mid-December.
The Senate then passed a bill extending the debt ceiling by $2.5 trillion on December 14, just one day before a deadline to reach the previous debt limit according to Secretary Yellen. The House ratified that measure as well and President Biden signed it into law, allowing the government to fulfill its obligations into early 2023. Importantly, this means the issue will not arise in 2022, a year of mid-term elections.
Had Congress failed to act on a timely basis, the federal government would not be able to issue debt and could run out of cash-on-hand. This raised the risk of the U.S. defaulting on its debt, as even interest payments on existing debt could not be made. Yellen, in her commentary, warned, “we could see indefinite delays in critical payments. Nearly 50 million seniors could stop receiving Social Security checks for a time. Troops could go unpaid. Millions of families who rely on the monthly child tax credit could see delays.” The debt ceiling extension passed by Congress in December avoided this scenario.
Some perspective on the debt ceiling debate
The fact that the issue is raised repeatedly often creates stress for the investment markets, even with the track record of Congress ultimately voting to raise the debt ceiling. “The issue itself is temporary, and ultimately, government spending catches up,” says Haworth. “The bigger question mark is what it might mean for the economy and financial markets.”
The biggest concern is that without the debt ceiling expansion, the government risks defaulting on its Treasury obligations. “Such a move could cause creditors to demand higher interest rates in order to provide capital to the U.S.” If that occurred, it could cause subsequent rate increases for other types of debt, including mortgages, consumer borrowing and business capitalization.
A similar impasse occurred in 2011, when Republicans in Congress squared off against Democratic President Barack Obama over the issue of raising the debt ceiling. At that time, investment markets proved to be very volatile as a deadline approached to take action. Two days before the date when the Treasury Department estimated that it would run out of funds using extraordinary measures, Congress voted to raise the debt ceiling.
Another consequence, however, was a downgrade of U.S. Treasury securities below the highest, triple-A level for the first time in history, by a major credit rating agency. That did appear to cause higher interest rates on U.S. Treasuries as a result.
“While the debt ceiling issue potentially raises concerns for the bond market, investors may also become concerned with the fast-increasing level of debt that continues to emerge in the current federal spending environment,” says Haworth. He anticipates that at some point in the future, the amount of debt that’s been issued, much of it in the form of COVID relief, will impact the supply-demand balance for bonds, possibly affecting interest rates.
Economic and market considerations
If the debt ceiling issue arises again and becomes difficult to resolve on a timely basis, it could cause a hit to the economy, though the damage may be short-lived. “Typically, one of the first spigots to be shut off is salaries to federal workers,” says Haworth. Ultimately, the pain may spread to those who receive direct payments from the government, such as Social Security recipients. “There are short-term impacts from that,” says Haworth, “but once funding is restored, everyone is usually made whole.” He points out that this can create financial difficulty for many and takes a meaningful human toll. Yet the overall impact to the economy is limited.
As for the investment markets, the debt ceiling confrontation created another issue adding to a degree of uncertainty facing a stock market that is already valued at a modestly high level. The market is also contending with concerns such as persistently high COVID-19 infection numbers and the new Omicron COVID variant to question marks about recent developments in China that may have economic consequences. This includes a seemingly stronger hand exercised over the free markets by China’s leadership and the recent financial difficulties facing a major Chinese real estate developer. “There were concerns that if the debt ceiling issue derailed confidence enough that companies began to scale back their own spending, that could have negative ramifications,” says Haworth. Haworth took some comfort in the fact that we’ve been in this position before, with Congress delaying an agreement on lifting the debt ceiling, and come out of it with no lasting damage.
Managing the government’s budget
The debt ceiling was only one of two key budget issues that Congress needed to address as 2021 draws to a close. Just before the government’s fiscal year ended on September 30, Congress passed a temporary spending measure to fund the government through December 3, but was unable to agree to a budget for the full fiscal year through September, 2022. On December 2, another extension was passed to continue funding government operations through February 18. However, a budget for the full fiscal year is yet to be approved. This issue remains open as 2022 gets underway. So while the debt ceiling issue has been settled, Congress will have to try to finalize the annual budget again more than four months after the new fiscal year is already underway.
It’s likely that the debt ceiling process will cause an impasse again in the future, while debates over the budget remain a common feature of politics in Washington. The legislative agenda can capture significant headlines from time-to-time, but represent just one factor to consider as you assess how your own portfolio is situated for the current environment and your long-term investment objectives. Talk to your financial professional if you have questions or want to discuss any options that should be considered for your portfolio.
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