The debt ceiling battle in the late summer of 2011 marked an infamous demonstration of government inefficiency. The debt ceiling, or the amount of debt the United States government can borrow through the sale of government bonds, is set by the U.S. Congress. In 2011, a steadfast Congress decided to use the debt ceiling as leverage in an effort to force proponents of loose fiscal policy to address the ever-growing debt of the United States. Simultaneously, the Obama Administration argued in favor of providing additional support in the form of government transfer payments, i.e. more spending, to drive an economy recovering from the recession of 2008. Ultimately, a deal was reached – but not before irreparable damage was done not only to the stock market, but to the credit rating of the United States government itself.

The S&P 500 Index dropped over 4.0% in the week leading up to the deadline to make a deal to raise the debt ceiling on August 1st, 2011.  On August 5th, Standard & Poor’s, one of the “big three” credit rating agencies responsible for grading the financial health of countries, states, municipalities, and corporations, downgraded the United States from AAA to AA+, marking the first time in history the United States had received a rating below the highest rating given by the agency.

Overall, the S&P 500 dropped over 16.0% between July 22nd and August 19th of 2011.  Upon this low in August, the S&P 500 eventually reached back to its July 22nd level in early February of 2012, and continued to move even higher from there. Political uncertainty temporarily paralyzed the markets, and it has the potential to do it again this year when Congress is back in session after their August recess.

The United States debt ceiling stands at about $16.699 trillion, with the official debt lying right below that number. Jack Lew, the current Treasury Secretary, stated in a letter written to Congress* on May 17th that the Treasury Department will begin to take “extraordinary measures” to ensure the debt stays at this level until Congress passes a bill to raise the debt ceiling once again.  These measures include:

  • Suspending the sale of State and Local Government Series Treasury securities
  • Redeeming existing and suspending new investments of the Civil Service Retirement and Disability Fund and the Postal Service Retirees Health Benefit Fund
  • Suspending reinvestment of the Government Securities Investment Fund
  • Suspending reinvestment of the Exchange Stabilization Fund

Lew stated these provisions would provide an additional $260 billion to buy time for legislation to be passed.  He estimates this will keep the United States out of default “until after Labor Day”.

House Republicans have proposed legislation, known as the Debt Prioritization Bill, to allow the U.S. Treasury to continue borrowing money to pay the interest on debt and Social Security obligations provided one of a list of options is enacted:

  • Long Term Solution
    • Allows Treasury to borrow for rest of Obama’s second term
    • Privatize Medicare and/or Social Security
  • Medium Term Solution
    • Allows Treasury to borrow until sometime in 2015
    • One of the following items:
      • Cuts to food stamp program
      • Block-grant Medicaid
      • Large raise in retirement age
      • Change to chained CPI
  • Short Term Solution
    • Allows Treasury to borrow until first half of 2014
    • One of the following items:
      • Means testing for social security
      • Small raise in retirement age
      • Ending agricultural subsidies

The Obama administration responded with a Statement of Administration Position on May 7, 2013: “We will not negotiate over the debt limit. The creditworthiness of the United States is non-negotiable. The question of whether the country must pay obligations it has already incurred is not open to debate. Congress has no choice but to protect out creditworthiness and our economy.”

It is unclear how this debate will be resolved this time around, but it is certain we are in for some political grandstanding, if nothing else.  The timing of this debt ceiling debacle coincides with the just-as-crucial decision by the Federal Reserve on whether or not to begin tapering its quantitative easing program. The result could mean a volatile market in the next couple of months.  We at the Legacy Foundation will be implementing positions that may mitigate this as the situation unfolds.

*To see this letter in full, view the PDF at the bottom of this article:

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