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Are we about to have another debt ceiling debacle?

Question of the Week - August 28, 2017

Website Administrator - Monday, August 28, 2017

Are we about to have another debt ceiling debacle?

It's certainly possible, but could be less likely than the prior mess in the summer of 2011. Stocks hit another patch of volatility mid-week, as the President threatened to hold up debt ceiling negotiations in September and even force a government shutdown until certain parameters were met. However, economists appear to be putting the odds of shutdown at far less than half, and Congressional sentiment appears focused on avoiding a shutdown this time. These are actually two separate bills—one to extend the ceiling and other a continuing resolution to keep the government running—both of which come due at the end of Sept.

Before this decade, threats over issues as serious as not funding the government were less common, so the idea of a bad outcome during these routine matters was less fathomable. The ceiling has been raised many times already over the years and has been considered merely a legislative formality. Some policymakers would like to abolish the rule altogether, noting the legislative process behind it creates more risk than benefit; others feel the procedure provides accountability and limits the 'blank check' of government spending.

This changed in 2011, as political polarization in Congress worsened and the game of 'chicken' progressed, so the chances of a miscalculation rose and caused markets to react very unfavorably. Debt rating agencies were also less than pleased, as Standard & Poor's actually proceeded with the downgrade of U.S. debt from AAA to AA+, while Moody's and Fitch retained the highest status, albeit adding a 'negative watch' caveat. This actually was, and still is, a big deal, since U.S. Treasury bills and bonds are considered the default global 'risk-free' asset with the idea of default virtually unthinkable. It's also a reminder that credit is not only a matter of ability to pay, but also the willingness to pay; the latter component was the clincher in that particular case. But, as expectations turned to hope, then to relief, the situation six years ago resolved itself and the debt ceiling was increased.

Odds of such an event appear lower this time around, despite Presidential rhetoric about closing government and holding out in an effort to fund 'The Wall', since it appears the involved parties recognize the importance of the matter and don't want to repeat the 2011 episode where investment markets and rating agencies didn't take such threats lightly. Fitch has again threatened a downgrade if Congress doesn't increase the limit, as they have before. (Yes, there is irony here in regard to the rating agencies—as a downgrade could happen from taking on more debt. Typically, limits on debt and lower overall borrowing levels tend to be a credit positive; but, in this case, the uncertainty over government operations and lack of funding for immediate coupon payments would outweigh the longer-term impact.)

Expect a lot more to come on the topic during the next few weeks—much of which could be just be political noise. This could include the inclusion of other legislation to incent passage of the bill, with haggling on both sides in the meantime, per usual. Fortunately, this is being taken as a more serious matter this time around.

Read our Weekly Review for August 28, 2017.

Read the previous Question of the Week for August 21, 2017.

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