VCU news

By Leila Ugincius

Is the United States about to default on its loans? As the estimated mid-October deadline — the date the government is expected to run out of its borrowing authority — looms, anxiety is rising about the potential fallout. Could this actually happen?

Kenneth Daniels, Ph.D., professor of finance in the VCU School of Business, talks about the debt limit, including its history, the worst-case scenario if it isn't raised and how this issue is affecting our financial markets.

What does it mean that the country is running out of borrowing authority?
Congress should act as early as possible to extend normal borrowing authority in order to avoid the risk of default and any interruption in payments. The Treasury is authorized to issue debt needed to fund government operations — as authorized by each federal budget — up to a stated debt ceiling, with some small exceptions. When the debt ceiling is reached, Treasury can declare a debt issuance suspension period and utilize "extraordinary measures" to acquire funds to meet federal obligations but which do not require the issue of new debt. One example is to suspend contributions to certain government pension funds. However, these amounts are not sufficient to cover government operations. Treasury first used these measures on Dec. 16, 2009, to remain within the debt ceiling, and also used it during the debt ceiling crisis of 2011.

If the extraordinary measures were allowed to expire without an increase in borrowing authority, Treasury would be left to fund the government solely with the cash we have on hand on any given day. As you know, cash would not be adequate to meet existing obligations for any meaningful length of time because the government is currently operating at a deficit.

How did this happen? Why are we running out of borrowing authority? How was this mid-October deadline to raise our debt limit determined?
Treasury Secretary Jack Lew notified Congress that estimates show the U.S. hitting the debt limit by the middle of October. The U.S. government makes approximately 80 million separate payments per month. These include payments for Social Security; Supplemental Security Income; Medicare; Medicaid; national security needs, including military salaries, military retirement, veterans’ benefits and defense contractors; income tax refunds; federal employee salaries and retirement; law enforcement and operation of the justice system; unemployment insurance; disaster relief; goods and services sold to the government under contracts with small and large businesses; and many others. If Congress does not act to extend borrowing authority, all of these payments would be at risk. This would impose severe economic hardship on millions of individuals and businesses across the country.

What would happen if the debt limit isn't raised?
It is important to point out that extending borrowing authority does not increase government spending — it simply allows the Treasury to pay for expenditures Congress has previously approved. Failure to meet those obligations would cause irreparable harm to the American economy and to the livelihoods of all Americans. Even a temporary default with a brief interruption in payments that Congress subsequently restores would be terribly damaging, calling into question the willingness of Congress to uphold America’s longstanding commitment to meet the obligations of the nation in full and on time. It should also be noted that default would increase our borrowing costs and damage economic growth and therefore add to future budget deficits, not decrease them. More importantly, this unnecessary uncertainty hurts business confidence, which will jeopardize the fragile recovery that is now underway in our economy.

How does raising our debt limit help the country's credit-worthiness? If I max out my credit card, and my credit card company raises my limit, and I then go and max it out with the new limit: aren't I just digging a deeper and deeper hole for myself?
The American public needs to know that extending borrowing authority does not increase government spending. It simply allows the Treasury to pay for expenditures Congress has previously approved. This allows our nation to protect the full faith and credit of the United States. This is the responsibility of Congress because only Congress can extend the nation's borrowing authority. Failure to act responsible with the creditworthiness of the U.S. Treasury is a dangerous game that could ultimately lead to a downgrading of our credit rating and increased interest expenditures on U.S. Treasury debt. This would lead to an increase in the cost of capital for almost every firm in our economy given the role played by U.S. Treasury debt as an indicator of low cost debt.

How did this practice of borrowing from other countries start? Is it really a good idea?
Because a large variety of people own the notes, bills and bonds in the "public" portion of the debt, Treasury also publishes information that groups the types of holders by general categories to portray who owns United States debt. Foreigners own approximately 32 percent of the total debt of $14.1 trillion. The largest holders were the central banks of China, Japan, Brazil, Taiwan, United Kingdom, Switzerland and Russia.

In recent years, many countries’ deficit-to-GDP (gross domestic product) and debt-to-GDP ratios rose as governments increased their borrowing on international credit markets to finance spending. For some European countries in particular, the ratios reached far beyond those considered sustainable. Consequently, these countries — including Greece, Ireland and Portugal — saw their borrowing costs rise dramatically as markets began questioning the countries’ ability and willingness to repay their debt.

Although the U.S. continues to have low borrowing costs, the U.S. deficit-to-GDP and debt-to-GDP ratios are nearly as high as those of some of the countries that have had difficulty borrowing. The current European sovereign debt crisis serves as a wake-up call for the U.S. fiscal situation.

How serious is this issue? Could it realistically be solved by Congressional bipartisanship?
I am not a political economist, so I would be guessing at this question. I will say it is unfortunate that Congress wants to use the debt ceiling as a bargaining chip. Recently, House Republicans have floated using the debt limit as leverage to defund President Barack Obama's health care reform law and Secretary Lew has indicated that President Obama will not negotiate with Congress on the debt ceiling. This unfortunate scenario will bring additional uncertainty to our financial markets and make the economic recovery more difficult.

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