How the dominoes will fall if the worst happens with the debt ceiling

Zachary Halaschak

May 09, 05:30 AM May 09, 05:30 AM

The United States is inching closer to the deadline for action on raising the debt ceiling. Here is what will happen as that date approaches — or even lapses.

It has been months since the government hit its $31.4 trillion debt ceiling, and both Democrats and Republicans want to raise the cap, although Republicans are using it as an opportunity to score concessions like spending cuts.

IF CONGRESS DOESN’T RAISE THE DEBT CEILING – THE OPTIONS, FROM UGLY TO UNTHINKABLE

President Joe Biden and Republican leadership now must negotiate a deal and are set to meet Tuesday afternoon. Any agreement, though, is likely to come down to the wire, and there is a small possibility that the worst-case scenario occurs and the two sides fail to make an agreement on time.

House Speaker Kevin McCarthy (R-CA) offered up a plan that would raise the debt ceiling over the next year either by $1.5 trillion or until March 31, 2024, whichever comes first. But the plan would cut back on spending and includes other provisions that are unacceptable to Democrats in the Democratic-controlled Senate, such as beefed-up work requirements for welfare.

Here's a timeline of the the expected economic repercussions over the next few weeks.

Market turbulence

The longer the two sides fail to come to an agreement, the more markets will react as investors fear default. It is worth noting that the U.S. has never defaulted on its obligations in all the times Republicans and Democrats have sparred over the ceiling, with an agreement always being inked in time.

Still, the mere perception that the Treasury might run out of “extraordinary measures” to pay incoming bills would roil the markets. Such measures have been used at least 16 times since first being deployed in 1985, according to the Committee for a Responsible Federal Budget, and as recently as two years ago.

The bond market has already begun to react. Yields on Treasury securities maturing in June, when the government may lose its ability to pay all of its incoming bills in full and on time, are now higher than many of the yields for those maturing before or after that month, according to Monday’s readings. Yields in July are also high.

For instance, Treasurys maturing on June 15 have yields of about 5.19%, while those maturing on May 15 have yields at or below 5%. Those maturing in September and October all have yields below 3%.

Credit default swap spreads for Treasury securities have been widening. The swaps, known as CDS, are a form of insurance against default. CDS spreads typically go up as investors see the entity in question as being riskier.

The stock market will also be socked the closer the country comes to missing a payment on a bill that is due. While recent movement up and down in the stock market is also being influenced by other factors (the Federal Reserve raising interest ranks, ongoing uncertainty in the banking sector, etc.), if the now-long odds of a default increase, investors may panic and start selling off riskier assets like stocks, causing markets to plummet.

Credit downgrade

Amid the chaos, the U.S. could have its credit rating downgraded. The worst debt ceiling standoff that has occurred thus far, which happened in 2011, caused Standard and Poor's to downgrade the country’s credit rating, having it fall below AAA (outstanding) for the first time in history.

Stocks would undoubtedly be walloped by news of such a downgrade. On the day that S&P moved the U.S. rating to AA+, markets went tumbled. The stock market had its worst day since the outset of the 2008 financial crisis, with the Dow Jones Industrial Average plunging 5.6% and the S&P 500 nosediving nearly 7%.

Brian Riedl of the Manhattan Institute told the Washington Examiner that the country could end up facing another credit downgrade against the backdrop of the current standoff.

“Possibly — I mean, if we get closer to it, yes,” he said.

The Treasury misses payments

This is the worst-case scenario. In this situation, both sides, Democrats and Republicans, played a game of chicken, and the American economy lost. The effects would be immediate and would reverberate throughout the world.

Treasury rates would soar while the stock market would crash.

Mark Zandi, chief economist at Moody’s Analytics, testified to Congress that even with a short default, a “crisis, characterized by spiking interest rates and plunging equity prices, would be ignited. Short-term funding markets, which are essential to the flow of credit that helps finance the economy’s day-to-day activities, likely would shut down as well.”

Fitch Ratings said right after a technical default, “the US’s rating would be moved to 'RD’ (Restricted Default) [and] affected Treasury securities would carry a ‘D’ rating until the default was cured.”

If there is a default, the Treasury might attempt to prioritize payments — that is, paying some bills while allowing others to go unpaid. Such efforts have been discussed in the context of past debt limit standoffs but have always been rejected by the Treasury as unfeasible.

In 2011, the Obama Treasury developed a contingency plan to use incoming tax revenue to keep making payments on the principal and interest on the federal debt.

The plan Treasury had sketched out dictated that incoming tax revenue be used to make payments on the principal and interest on the federal debt. A 2012 Treasury inspector general's report found that the least-harmful plan would be a “delayed payment regime,” in which “no payments would be made until they could all be made on a day-by-day basis.”

For instance, if interest payments were prioritized, Social Security payments could be delayed, border control and air traffic control could be left temporarily unfunded, and things as simple as government-funded school lunches could be at risk.

Many economists and officials have pointed out the complexity, both practically and technologically, of being forced to prioritize payments.

House Republicans could also call for the Treasury to make payments to other high-priority obligations like Medicare, the military, Social Security, and benefits for veterans. That would be a divisive move because other items like Medicaid, air traffic control, and thousands of other programs might end up unprioritized.

Default is still unlikely

Given the massive implications, economic and political, of a default occurring, it is very unlikely that neither side flinches and allows a technical default. Even in 2011, when it appeared possible, a deal was ultimately reached.

Maya MacGuineas, president of the Committee for a Responsible Federal Budget, told the Washington Examiner on Monday that she thinks a temporary patch, raising the debt limit just for a month or two, could be helpful because it would give both sides more time to work on a negotiated agreement. She also thinks a default is not a likely outcome.

“I still think it is highly unlikely that they will default because there is such a clear compromise to be had, meaning we will have savings but it should be negotiated as part of the budget. An important thing is they start these discussions quickly,” MacGuineas said.

How Manchin and Sinema are helping Republicans plot a big win over Democrats and Biden

Jack Birle

May 03, 09:40 AM May 03, 09:40 AM

Sens. Joe Manchin (D-WV) and Kyrsten Sinema (I-AZ) may be the GOP's key to victory in the battle over the debt ceiling, as Democrats and the White House push for a deal to raise the limit without any negotiations.

In a break from their Democratic caucus, both senators are calling for negotiations and could stall Democratic pressure in the Senate for the House to pass a debt ceiling resolution with no stipulations.

SIGNS OF STRESS START TO BUILD IN MARKETS AS DEBT CEILING DEADLINE LOOMS

Manchin has called on President Joe Biden to negotiate with the GOP and other congressional leadership and has expressed optimism for a planned meeting between the parties next week.

"I hope President Biden's invitation to Congressional leaders is sincere and he is genuinely willing to negotiate because the country cannot afford a failed negotiation," Manchin said in a statement on Monday. "Every day without action brings the American government closer to default and the American people closer to economic chaos. I urge President Biden to show true leadership and finally put politics aside and the well-being of our nation first.”

The West Virginia Democrat also told Politico that he has communicated to House Speaker Kevin McCarthy (R-CA) that regarding the debt ceiling bill passed in the House, "there’s things I don’t like in there, but there’s a lot of things we can agree on."

Sinema, who left the Democratic Party in December 2022, also expressed concern over the coming debt ceiling deadline and has urged both sides to negotiate.

“Both sides need to come together, put down the partisan talking points, and discuss realistic solutions to prevent default,” Sinema said to the outlet.

The Arizona independent has also reportedly "quietly dined" with McCarthy and has expressed a desire to come to an agreement with Republican senators, per Politico.

Both Manchin and Sinema face difficult reelection bids for their Senate seats in 2024, but neither has publicly said whether they will seek an additional term in the upper chamber of Congress.

Manchin would likely face popular Gov. Jim Justice (R-WV) if he runs for reelection in the heavily GOP state. Polling suggests Justice holds a significant advantage in opinion polling compared to the incumbent senator, with a 66% approval rating compared with Manchin's 38% approval rating.

The West Virginia Democrat has positioned himself against Biden, who is deeply unpopular in the Mountain State, by coming out against some of the president's recent proposals.

Manchin has come out strongly against a rule that would halt tariffs on Chinese solar panel manufacturers, saying he "cannot fathom why the Administration and Congress would consider extending" reliance on China.

He has also gone after Biden for the way his administration has implemented the Inflation Reduction Act, which he served as the key vote for, even threatening to vote to repeal the bill if the Biden administration continues using it to fund "its radical climate agenda."

Sinema will likely face a three-way race if she decides to run for reelection, with Rep. Ruben Gallego (D-AZ) running from the left and a GOP candidate to her right.

Treasury Secretary Janet Yellen has said the U.S. is set to default on its debt obligations on June 1, leaving a short window to raise the debt ceiling. Biden and congressional leaders from both parties, including McCarthy, are set to meet to discuss the debt ceiling on May 9.