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The debt ceiling debate is on everyone’s lips inside the Beltway and on Wall Street. Outside of DC and New York, though, debts and deficits barely register as economic concerns: everyday Americans, polls have shown, are far more concerned about the grim jobs picture.
What many consumers do not realize is that an American default will shock their financial lives, in less of a trickle-down effect than a torrential rain. While many dismiss the debt ceiling crisis as political theater and scare tactics, no matter how the crisis plays out, consumers may pay heavily for the government’s irresponsibility.
A brief history of the debt ceiling
Until 1917, Congress had the sole authority to borrow money on behalf of the United States, and issued each debt separately. This grew to be inconvenient right around World War I, so to give the federal government more flexibility, Congress decided to set an aggregate borrowing limit known as the debt ceiling, which capped the total number of bonds that could be issued.
The Treasury issues bonds to fund programs that are approved by Congress, so since 1979, the House has automatically increased the debt ceiling when it passes a budget, except in rare cases – such as now.
Treasury Secretary Timothy Geithner is asking for an increase in the $14.3 trillion debt ceiling, warning that if he is not authorized to issue more bonds by August 2nd, the country will default on its debt. When in debt, it seems counterintuitive to borrow more, but because the US falls about $118 billion short of its obligations each month, the country has little choice.
At this point, the US is out of favorable options. Even if the government increases its debt ceiling now, the US’s ability to repay its investors (i.e. anyone who purchases US bonds) will be met with quite a bit of skepticism, making future investors more cautious. They will likely demand higher interest rates on Treasury bonds to compensate, just like a lender will charge higher interest based on a borrower’s credit score.
Even worse, if the ceiling stays put, the US would have to stop borrowing money. This may seem like the wise (and sane) decision until one realizes that the US borrows 43% of the money it spends. This means the government would have to prioritize it's spending in order to cut its budget by about half. Without issuing bonds, the government cannot pay for just Social Security, Medicare, Medicaid, military expenditures and its existing interest payments, to stay nothing of the judicial system, education and consumer organizations like the FDA and SEC. If the US should default, everyone from students hoping for a Stafford loan in the fall to seniors who rely on Social Security could be turned away.
Hit where it hurts: the ripple effects of the debt ceiling crisis
Even those who don’t directly benefit from federal funds through veterans benefits, unemployment insurance and the like will feel the pain of higher interest rates. The US’ debt is currently given the best possible triple-A rating by the two major rating agencies, S&P and Moody’s. If these two institutions downgrade the debt, the government’s cost of borrowing will rise significantly. This will not only force consumers to pay higher taxes to cover interest payments, but it will increase the interest rates they themselves pay on their loans, credit cards and mortgages. Most interest rates are priced as a markup from the amount the Treasury pays to borrow money. Treasury bonds are considered guaranteed to be repaid, but consumer loans are not, so lenders charge credit cardholders and other borrowers more to compensate for that risk. Consumers with bad credit will be hit the hardest, as theirs is the highest markup above Treasury bonds. If Treasury bonds aren’t considered failsafe, consumers will by simple arithmetic have to pay more.
Consumers will end up paying for politicians’ antics, whether through budget cuts, higher taxes, steeper interest rates or a painful cocktail of the three. No matter what the outcome in Washington, the effects of the debt ceiling debate will be felt throughout the nation and far beyond the 2012 elections.
Tim Chen is the CEO of NerdWallet, a credit card website dedicated to helping find low interest credit cards before and after August 2nd.
