What is the debt ceiling? The debt ceiling was enacted by Congress in 1917 to enable the US Treasury to more efficiently borrow in the public market. Prior to the debt ceiling, the US Treasury had to seek the approval from the Legislative Branch anytime it wanted to borrow (issue debt). During World War I, Congress authorized the US Treasury to issue debt subject to issue-specific limits; in 1939 Congress instituted the first limit on total accumulated debt of all kinds.
Why does the debt ceiling exist?
The ceiling exists to preserve the authority of the Legislative Branch over matters of the purse, effectively limiting the US Treasury’s power to issue debt. This ensures debate amongst elected representatives over federal borrowing and spending.
What happens when the US Treasury reaches the ceiling (debt limit)? Once the limit is reached, the US Treasury can no longer increase overall indebtedness. The debt ceiling would have to be raised through Congressional action or the constraint would need to be suspended.
The debt ceiling suspension enacted in 2019 expired on July 31, 2021 and it was not resuspended nor raised. So now what happens? First, US Treasury Secretary Yellen notifies the various House and Senate leaders she is enacting extraordinary measures. (Read the letter here.)
Because the limit was not raised, nor resuspended, the US Treasury uses extraordinary measures to pay its liabilities including salaries, benefits, debt service and other obligations.
What constitutes extraordinary measures? First, the Treasury will use the cash on hand in their General Account and, of course, any tax receipts. Anticipated tax receipts in September 2021 are expected to help. Second, they will borrow from other sources of cash within the government. Similar to a corporation borrowing from one of its divisions and lending to another, the US Treasury can borrow from one agency to fund another. All of these loans are temporary and will be repaid once the debt limit is raised or suspended. (Read more on this borrowing here.) While it is very difficult to gauge when the Treasury will exhaust their ability to operate using extraordinary measures, at the time of this writing best estimates would be early in the fourth quarter of 2021.
At the same time, during this period of extraordinary measures, the Legislative Branch is negotiating and debating on measures to raise the limit on the debt ceiling or resuspend the debt ceiling.
How often has the limit been suspended or raised? It is a very common occurrence. Some calculate the limit has been increased over 90 times in the last century. The debt ceiling has never been reduced. Congress has raised the debt ceiling 14 times from 2001 to 2016.
What happens if the debt ceiling is not raised or resuspended? If extraordinary measures are exhausted and Congress has not reached an agreement then the US Treasury must decide who not to pay. It’s generally thought that they would opt to delay payment on maturing treasury debt before they would not pay benefits or salaries. But there are vivid examples of government shut downs in the past decade when Congress failed to approve a budget and raise the limit.
Isn’t missing the payment the same as a default? Yes, but not in the truest sense of the definition. The US Treasury does have the ability to repay but the rule says it can’t. So they refer to this as a “technical default”. The Treasury came close to this in 2011, triggering a steep sell-off in equity markets and a downgrade of US Treasury debt by Standard & Poor’s from AAA to AA+. The downgrade was a clear signal to the House and Senate that political gamesmanship that risks default can carry a significant economic price tag.
Could this happen again? It could but is unlikely. There was political fallout from the events of 2011, and again 2013, as there was a perception that Congress was not doing their job. In the previous decade there was significant focus on our nation’s indebtedness, as the Tea Party had a great deal of political influence and government austerity was a major global theme. Today things have shifted. The focus is on spending and stimulus. Those trying to contain spending and reduce our debt don’t have as much influence.
Will the debt ceiling always be an issue? Is there any way to create a permanent fix? There is no way to create a permanent fix and still have Legislative control over the ability for the US Treasury to borrow. So as frustrating as it is, it is not going away.
Should investors in US Treasury debt take action to avoid owning debt that might be caught in a technical default? Historically we have seen some investors try to avoid owning specific US Treasury securities that might be at risk of default as extraordinary measures are exhausted. But getting this timing right can be challenging due to the fluidity associated with resolving extraordinary measures. Historically State Street Global Advisors’ cash desk has chosen not to play guessing games but to operate using our consistent and disciplined relative value approach to reinvesting maturing
proceeds. Our expectation is that Congress will resolve the matter and either approve a new suspension or increase in the limit.
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