Much Ado About Something (Debt Limits)

I probably get as many questions about the ramifications of the debt limit as I do about anything else.  One of my longstanding contentions is that investors generally have a difficult time dealing with geopolitical events, and the US debt ceiling is a political event – even if its consequences could have very real and debilitating effects on investments of all types.

The problem is that we are running deficits.  That means that spending is increasing faster than revenue, and the result is that our national debt grows.  It also means that our obligation to service those debts grow.  Much of the spending has been decided through years of budgeting when each of the political parties controlled the process.  Neither has shown much enthusiasm for curbing the deficits when they are in power.

Periodically we bump up against a debt ceiling.  That we do so is purely political.  Rather than coming up with a solution that could last us for a long period of time, Congress routinely agrees on short-term measures.  That is political.  There is tremendous political leverage to be potentially gained from the debt negotiations and both sides are loath to give up even an iota of leverage – even if it puts a periodic stress on our nation’s finances.

To be fair, we’ve seen this movie before.  Because we’ve had a series of debt limit fights that ultimately get solved, US investors are reluctant to overreact to the risk of failure.  Right now, I’m not so sure that global investors are quite so sanguine.  We noted yesterday that international markets are outperforming the US.  It is quite possible that those who can allocate capital globally are moving money of the US ahead of this potential stalemate.

As for consequences, they can be dire.  One of the sacrosanct assumptions underlying modern investing is that US Treasury securities bear no credit risk.  The US government has the means and methodology to pay its debts, but the debt limit can constrain that process in the short term.  Even a slight hiccup in our debt payments could cause investors to question whether US debt requires a higher risk premium.   If I’m a CFO who bought T-bills to invest cash that I will need in three months, what happens if I can’t access those funds on the promised date? 

We have noted before that if safe assets get clobbered, risk assets don’t stand a chance.  If a debt ceiling fiasco causes global investors to re-rate US Treasuries, that will spill into assets of all types in highly unpredictable ways.  I have faith that our Congress will put country over party and solve this problem – though not once and for all.  The question remains what might occur between now and then.

In the meantime, I wrote a short play to demonstrate the household equivalent of what is occurring with the debt ceiling.  I never like it when politicians compare household finances to the government – households don’t have the power of taxation or the ability to print money – but in this case I think it’s apt.  If we have any Pulitzer Prize or Tony Award voters among our readership, I humbly present the following for consideration:

MUCH ADO ABOUT SOMETHING (A Play in One Act)

A kitchen table in an ordinary suburban home.  Breakfast is served

JANE: (Jane Smith, a 40-ish suburban mother)

Honey, did you see this email?   The credit card company says we’ve maxxed out the limit on our Visa card.  I’m going to ask them to raise it.

DICK: (Dick Smith, Jane’s 40-ish husband)

My name is on the account too.  You can’t do it unless I approve.

JANE:

You will, right?

DICK:

I’m not sure.  We spend too much money in this household.  I want us to put a lid on it.

JANE:

That may be true, but we need to deal with this problem now.  I think we can put off the problem for a few months if we carefully sequence how we pay one bill or another, but we need to get this credit limit raised.

DICK:

That’s great, but I don’t want to raise the limit until you promise to stop spending so much.

JANE:

We can talk about our budget later.  In fact, we definitely should reassess our budget.  We need to.  But first we have to deal with the problem at hand. 

DICK:

Now?

JANE:

If we don’t get this limit raised, we’ll start missing payments.  Even with these huge balances, our credit rating is excellent.  But if we start missing payments it will wallop our credit rating.  And then it would be even more expensive to pay the interest on our outstanding debts.

DICK:

I tuned you out midway through your diatribe. How dare you spend so much?  You spend money on all sorts of stupid stuff.

JANE:

 Me?  You’ve spent a fortune and put it on the card!  When you were running our finances, you took out cash advances against bonuses that never arrived. 

DICK:

So stop spending so much now

JANE:

We have to pay the interest on that whether you like it or not!  Do you understand we can’t get ahead of our debt with our current income or spending?  Our balance will go above our credit limit whether we want it to or not. 

DICK:

Yeah, but  I want you to lay off the spending.  We pay our medical bills on the card and we send money to our parents’ nursing homes on the card.  I don’t want to do that anymore.

JANE:

That’s not so easy.  We’ve signed contracts to continue doing that for at least a year.  And we also told our creditors we’d pay them back.  We don’t really have a choice.

DICK:

 Don’t care.  Figure it out. 

JANE:

You do realize that this will have huge consequences for our finances if we don’t raise this credit limit soon, right?

DICK:

I do realize it, and I’ll likely say yes eventually.  But it’s my job to make you sweat about this every so often…

END SCENE