What happens if the government runs out of money? How debt ceiling crisis could impact your finances
- Congress has to raise the U.S. debt ceiling before Oct. 18, to prevent a first-ever default.
- It could mean a spike in mortgage rates and other consumer borrowing for Americans
- Government funding and the debt ceiling are separate issues.
It’s coming down to the wire for Congress to reach a deal on the national debt ceiling before the U.S. government runs out of money to pay its bills.
If lawmakers in Washington are unable to resolve the debt limit in time, and the Treasury begins paying its bills late, the United States could default on its debt – something that has never happened.
Lawmakers are at odds over raising the federal borrowing limit, or the debt ceiling, which allows the U.S. government to make good on its financial obligations. The debt ceiling, also referred to as the debt limit, or the amount the government can borrow, stands at $28.4 trillion. The national debt, the amount the government owes its creditors, is $28.43 trillion.
Congress has to raise the U.S. debt ceiling before Oct. 18, to prevent the first default. The Treasury Department can meet financial obligations for a while using tax revenue and cash reserves.
Separately, Congress has to pass a funding bill before midnight Thursday to avoid a government shutdown. Late Wednesday, Senate Majority Leader Chuck Schumer, D-N.Y., said on the Senate floor that Democrats had struck an agreement with Republicans on a stopgap bill to keep the government funded through early December.
The Senate is set to vote Thursday on the measure to avert a shutdown. The deal would still need to pass in the House.
Even if a shutdown is avoided, Congress will still have to grapple with the debt ceiling crisis. Failure to raise the debt ceiling by mid-October would make it impossible for the federal government to maintain its financial obligations that include payments to veterans and Social Security recipients.
Nearly 50 million senior citizens could face delays in their Social Security payments if Congress fails to suspend or raise the debt ceiling in the coming weeks, Treasury Secretary Janet Yellen told lawmakers last week.
“Our troops would not know when they would get their next paycheck," Yellen said during her Congressional testimony. "We have 30 million families who rely on the monthly child tax credits and they would not receive that relief, at least not on time.”
Republicans, who raised the debt ceiling under GOP President Donald Trump and prior administrations, balk at doing so again under President Joe Biden, a Democrat. Senate Republicans said Democrats, who control both chambers of Congress, should raise the debt ceiling themselves. Democrats argue that addressing the debt limit is a shared bipartisan responsibility.
On Monday, President Joe Biden called for a Senate vote this week on raising the debt limit, saying opposition from Republicans could create "a self-inflicted wound that takes our economy over a cliff.”
What does the latest political gridlock between Republicans and Democrats over the debt ceiling mean for your personal finances and investments?
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If the United States defaulted on its debt, it could create a scenario in which the economy may plunge back into recession after pandemic-related disruptions to financial markets worldwide.
The result: millions of job losses that had been recovered since the COVID-19 outbreak last year, according to financial experts.
It could also mean a spike in mortgage rates and other consumer borrowing for Americans, at least until the debt limit is resolved and Treasury payments resume, experts said.
Despite warnings of economic catastrophe, financial experts said the negative effects from the debt ceiling standoff would probably be limited for the economy and Americans' pocketbooks because economists and analysts widely expect that a deal will be reached before the Treasury runs out of money.
“For the moment, this is a situation to watch but not to panic about,” Brad McMillan, chief investment officer at Commonwealth Financial Network, said in a note. “The risks are real, but certainly not immediate, and even in the absence of a deal not as large as many fear.”
Here’s what you need to know:
What does the debt ceiling drama mean for financial markets?
The U.S. Treasury said the debt limit must be raised by Oct. 18, or it will exhaust the “extraordinary measures” it uses to manage the debt once the legal limit has been reached. At that point, the Treasury wouldn’t be able to pay all of its bills.
If the United States defaults on its debt, it would be more expensive for the Treasury to borrow money and could result in a credit rating downgrade.
Though markets might breathe a sigh of relief over averting a government shutdown, analysts noted that there is no clear path to dealing with the debt ceiling.
The federal government will shut down at midnight Thursday if lawmakers fail to approve a funding budget. That could lead to thousands of federal worker furloughs and may shut down many national parks. It may delay mortgage and other loan applications if the IRS is forced to stop verifying income and Social Security numbers.
The debt ceiling is viewed as a greater economic threat if Congress fails to suspend or raise the U.S. borrowing limit, which would result in a historic default and result in havoc for the financial system.
Since neither party has a clear exit strategy, it could be a tense few weeks in Washington which could add to market volatility, analysts said.
Financial markets are still relatively calm.
That’s likely because it has become standard practice for Congress to run down the clock in these situations, then figure out a way to raise the debt ceiling when absolutely necessary, experts said. It’s widely expected that Congress will do so again.
“Given where we are in the economic recovery and since we’re not completely out of the woods with COVID and supply chain issues, I think the government will avoid at all costs creating a political nightmare that would put more pressure on the economic recovery,” said Liz Young, head of investment strategy at SoFi, an online personal finance company.
What does the debt ceiling gridlock mean for your 401(k)?
If the debt ceiling is triggered, it would be unchartered territory and could lead to instability in financial markets.
Long-term investors should stay the course and not let short-term events dictate their investment decisions, according to Michael Sheldon, chief investment officer and executive director at investment advisor RDM Financial Group at Hightower.
“Like many of these crises in Washington over the past several years, calmer heads will likely prevail at the last minute,” Sheldon said. “For investors thinking long term who are putting away money for retirement, this will probably be short-lived, so you want to continue to focus on your long-term investment objectives.”
These expectations may be stronger than in times past since Democrats control both the executive and legislative branches of the federal government.
Investors expect this deadline won’t be as disruptive as those in 2011 and 2013, during budget stalemates in the wake of the global financial crisis.
The debt ceiling impasse in the summer of 2011 caused Standard & Poor's to downgrade the country’s credit rating by a notch to AA+, which added to market volatility.
This isn't an economic crisis.
The United States can borrow enough money to pay its bills. This debt dispute is predominantly a political issue, according to Thomas Martin, senior portfolio manager at Atlanta-based GLOBALT Investments.
“The U.S. has never defaulted on its Treasury securities. It’s highly unlikely it will happen,” Martin said. “If it did, it would be a disaster.”
“Most of this is political posturing,” Martin said. “Each party is trying to get the other side to get closer to what they want.”
What is the economic fallout if the debt ceiling isn’t raised?
The economic effects of such an unprecedented event would be negative for the recovery, financial experts said.
Last week, Yellen told Congress that the Treasury would be unable to pay all of the government’s bills if the debt ceiling isn’t raised by Oct. 18.
“The full faith and credit of the United States would be impaired, and our country would likely face a financial crisis and economic recession,” Yellen told the Senate Banking Committee.
A U.S. default would be “potentially catastrophic,” Jamie Dimon, chief executive of JPMorgan Chase, said in an interview with Reuters last week, adding that the country’s biggest lender has begun planning for how a potential credit default would affect the repo and money markets, client contracts and its capital ratios.
“This is like the third time we’ve had to do this,” he told Reuters.
What does it mean for the economy?
There is an “enormous amount of uncertainty” surrounding the speed and magnitude of the damage the U.S. economy would incur if the government was unable to pay all its bills, according to the Brookings Institution, a nonprofit public policy organization.
It depends on how long the situation lasts, how it is managed and the extent to which investors alter their views about the safety of U.S. Treasurys, experts at Brookings said.
An extended impasse is likely to damage the U.S. economy, according to Mark Zandi, chief economist of Moody's Analytics.
If the United States defaults, there would be more damage that would upend the stock market. If the impasse dragged on, the government would have to cut spending, such as Social Security payments and the nation would be plunged back into recession with 6 million job losses, a 4% decline in gross domestic product and a 33% plunge in stock prices that would wipe out $15 trillion in wealth, Zandi predicted.
“Since U.S. Treasury securities no longer would be risk-free, future generations of Americans would pay a steep economic price,” Zandi said in a note to clients.
Even in a best-case scenario in which the impasse was short-lived, the economy would probably face challenges, he said. If the United States doesn't default but investors worry about the nation's ability to pay interest to Treasury holders and fund Social Security and all other obligations, it would probably push up interest rates for a brief period and hurt the economy.
The debt ceiling impasse in 2013 cost the economy 1% in GDP by 2015, and there would have been 1.2 million more jobs, according to Zandi.
Treasury yields, mortgage rates and other consumer and corporate borrowing rates would spike, at least until the debt limit was resolved and Treasury payments resumed, Zandi said.
"Even then," Zandi said, "rates never fall back to where they were previously."
Contributing: Paul Davidson