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Deconstructing the Debt Ceiling and What Investors Should Know About the Latest Bill Thumbnail

Deconstructing the Debt Ceiling and What Investors Should Know About the Latest Bill

Investments

So, the debt ceiling crisis finally subsided over the weekend. Nothing is more dramatic than the government waiting until the last minute to keep our country from imploding every 2 years. After all this forced tension and constant barrage of news coverage and melodrama (Are we going to default? What will become of us if we do? The sky is falling!), the end was pretty anti-climactic. It seems to be more political theater than anything else. Fortunately, that’s because every time the government does this, they manage to come to a resolution. The reason the debt ceiling continues to be a big deal is because if a resolution is not tenable, things could very easily go very wrong. Having said that, let’s do a little dive into what the debt ceiling is, why it’s important, and what was in the bill that was passed this time.

Let’s begin with an explanation of the debt ceiling. To start, governments often need to borrow money to cover budget deficits that fund important projects like infrastructure or defense. They do this by issuing government bonds or treasury bills. Investors lend the government money by buying the bonds/treasuries with the promise of a return of payment plus interest after a certain amount of time.

To prevent excessive spending and control the nation’s debt, the US government isn’t allowed to borrow an unlimited amount of money. That’s what the debt ceiling is. It’s the total amount of money the government can borrow, or the legal amount of debt the US is allowed to accumulate. Once the government reaches the debt ceiling, it can no longer issue any more bonds or bills to continue to borrow more money. But that doesn’t mean the spending has stopped. They still have to pay government employees, fund social programs like social security, and service existing debts. If the government runs out of money, that could cause a government shutdown, delays in payments including social security and military salaries, a downgrade of the country’s credit rating, and economic instability. If the US defaults on its debts, it could trigger a financial crisis that would have severe consequences for the US economy and the global financial system.

When the debt ceiling is reached, the government has a couple of options – they can cut spending, increase tax revenue, use accounting maneuvers to temporarily free up funds, or they can increase the debt ceiling through legislation. The latter is the most typical response we have seen in recent years and that’s what happened over the weekend – congress passed a debt ceiling package.

What was in this package and who won? The most important thing about the debt ceiling bill is that it suspends the nation’s borrowing cap until January 1, 2025 – meaning the government can spend beyond the ceiling for the next 1.5 years. It doesn’t raise the debt ceiling by a specific dollar amount, it just allows spending to continue until the ceiling needs addressed again in 2025.

The bill also includes:

  • A cap on non-defense discretionary spending. The cap keeps spending in 2024 to remain level with current spending levels and it allows for a 1% increase in spending in 2025. There is no cap after 2025, just non-enforceable targets.
  • A clawback of roughly $28 billion in unspent funds from the Covid-19 relief packages.
  • Cuts around $80 billion in IRS funding over the next 10 years.
  • Protection to veterans by fully funding their medical care.
  • An expansion of work requirements for SNAP (food stamps) and TANF (Temporary Assistance for Needy Families). The age requirement for able bodied adults to be employed at least 20 hours a week went from ages 18-49 to ages 18-55.
  • An end to student loan payment suspensions. Repayments are to begin after the end of August. It does not impact the debt relief package which is currently before the Supreme Court.
  • An expedition of a natural gas pipeline in West Virginia. The bill also streamlines the environmental review process by designating a single lead agency to be tasked with developing a single environmental review document.

As for which side won, both sides muddled through. The White House defended its positions that were important to them. Republicans wanted to defund clean energy subsidies. That didn’t happen. They also wanted to eliminate student debt relief. That also didn’t happen. Republicans did save face by cutting spending, although those cuts are less than they might appear. For example, the work requirements for SNAP and TANF may increase federal spending because it excused groups like veterans, the homeless, and foster care children. Also, the funding cut to the IRS could raise budget deficits because that money was supposed to be used to boost tax enforcement.

All in all, the market and DC have adjusted to this bi-annual ordeal. This doesn’t mean we should assume it will always be resolved. The reason we are one of the few countries that has a debt ceiling is for the purpose of leverage. If one side decides not to play, there could be dire economic consequences globally. It’s important that we don’t become so polarized that the two sides can’t work together to prevent an economic disaster.

As a financial advisor, it's crucial to stay informed about economic and political developments that can impact our clients' financial well-being. The debt ceiling issue is a recurring event that highlights the importance of maintaining a diversified investment portfolio and having a long-term financial plan in place. While the recent resolution may have provided temporary relief, it's essential to remain vigilant and prepared for future uncertainties. If you need help reviewing your financial goals, assessing your risk tolerance, or ensuring you have a solid contingency plan in case of potential market disruptions, please email me at jennifer.jenkins@bluestonewp.com. I am happy to help you navigate the ever-changing financial landscape and strive for long-term financial stability.

 

 

Watson, Kathryn. “What’s in the Debt Ceiling Deal — and What’s Not.” CBS News, 2 June 2023, www.cbsnews.com/news/whats-in-2023-debt-ceiling-deal-bill-to-avoid-default.

Luhby, Tami. “Here’s What’s in the Debt Ceiling Package.” CNN, 2 June 2023, www.cnn.com/2023/05/30/politics/whats-in-the-debt-ceiling-deal/index.html.

Prideaux, J., Howard, C., and Kahloon, I., hosts. “Checks and Balances: Seal the Deal.” The Economist Podcasts, iTunes app, 2 June 2023.