The Debt Ceiling Impasse

The lead economic story on all of the newscasts lately has been the political negotiations about the raising the debt ceiling. According to the Treasury Secretary, if the ceiling is not raised by August 2, the government will run out of money. The appeal of an impending crisis with a fixed deadline makes for a compelling news story – print and television accounts embellish the crisis with hyperbolic headlines (Armageddon is a common word). The basic questions investors might ask are 1) how likely is this to happen, 2) what would occur if it did happen, and 3) what should they do with their portfolio?

First, while both political parties appear to be playing a game of “chicken,” the likelihood of the lack of agreement causing a government default is very low. Indeed, the requirement to raise the ceiling has become nearly an annual event (it has occurred 10 times in the past 9 years). Sometimes the negotiations go smoothly, and sometimes the discussions are politically charged. Indeed, despite the rhetoric, both sides have recently signaled room for compromise. Of course, as is case in any conflict, resolution is never certain. So while the likelihood of a default is low, no one can claim that it is not at least possible.

The common perception is that the U.S. Government has never defaulted on its debt. It actually did as recently as 1979 – during a dispute about raising the debt ceiling, some government payments did not get made. And while there was some disruption in payments, and interest rates were slightly higher as a result of the reduced credibility of the government, clearly the situation of a government default was not as apocalyptic as the media currently suggests. More recently, a budget dispute between the President and Congress in late 1995 led to a shutdown of many non-essential government services for several weeks. Although not directly related to a debt-ceiling, it also showed that the failure to meet a deadline needed to maintain existing government services was survivable.

What would likely happen if agreement was not reached by the August 2 deadline is a freeze on some government payments, resulting in increased pressure on both parties to resolve the crisis. As the stakes got higher, the likelihood of a compromise would increase. Neither side wants to be known as the party that caused significant damage to the economy. With our perspective on the political negotiations, it is not surprising that we are recommending no changes to investors’ portfolios as a result of the impasse. Trying to forecast the unforecastable can be an interesting dinner-table activity, but is seldom the stuff of solid portfolio analysis. Indeed, taking actions because of the fear of the impact of unlikely events can often lead to damaging disruptions to a portfolio. For that reason, we suggest you monitor the political theater currently taking place, extracting whatever enjoyment or frustration that it typically provides, but not be concerned about the impact of your investments.

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