Debt Limit 101: Myth Busting and The Alarming Prospect of Default

Increasing the debt limit is deeply unpopular. A recent Gallup survey shows that Americans are opposed to raising the debt ceiling by a whopping 47% to 19% margin (while 34% say they don't know enough to say either way).

Well, 47% of us are wrong. Of course, the question was based "from what you know or have heard" on the debt ceiling. That may be the problem. The media has done a piss poor job of explaining what the debt limit actually is, what raising it means, and what not raising it would mean. The unpopularity of raising the debt limit comes from two primary myths about the debt limit: first, that raising the debt limit means raising the actual obligations of the federal government. The second myth is that not raising the debt limit will prevent the actual debt from going up. Neither is true.

Let's discuss those two myths with simple analogies before we go onto the really serious, catastrophic consequences of not increasing the debt limit. The debt limit is, of course, the amount of money the federal government is allowed to borrow to pay obligations already authorized by Congress. Since the national debt is often likened to a national credit card, these myths are busted well enough using the same analogy. First, if your credit card company raises your credit limit, it does not mean that you will automatically have a bigger bill. Similarly, if you reach your credit limit and become unable to borrow any more, it does not mean that your existing debt isn't still accruing interest, late fees, etc. even above and beyond your credit limit.

The case is very similar for the government. Raising the debt limit does not authorize any new spending. It does, however, enables the government to pay its existing obligations. Only Congress can authorize new spending, and that is a process independent of adjusting the debt limit. On the other hand, failing to raise the debt limit will only make the debt itself worse. Firstly, even without a rise in the debt limit, interest on our debt will continue to grow, and not paying will accrue interest on top of the interest. Thus, the government - meaning the taxpayers - will end up owing more money than if financing were available for us to continue to make the payments. Reaching the debt limit also means that the government will run out of needed financing and will have to default on its loans (i.e. the debt payments). What happens to you when you default on a loan? Your interest rate goes up. If the government defaults on its debt payments, the interest rate that it pays, too, will skyrocket for any future borrowing. The whole thing will only make our national debt worse, not better. As Treasury Secretary Geithner explained in a recent letter to Sen. Michael Bennet (D-CO),
Default would also have the perverse effect of increasing our government's debt burden, worsening the fiscal challenges that we must address and damaging our capacity for future growth. It would increase rates on Treasury securities, which would significantly increase the cost of paying interest on the national debt.
Refusing to raise the debt limit is like stopping paying your mortgage and hoping it will go away.

Ironically, a bigger debt may be one of the least worrying outcomes of failing to raise the debt limit. The consequences will be far more dire in our financial system, and I guarantee you, in your pocketbook. If the debt limit is broken and there is no financing available, the financial calamity will make the 2008 financial meltdown look like the good old days. Why? Because the US treasury bond is the most secure investment in the world, which means that a default on it will throw every financial institution into chaos as the very basis of the financial market - the trust in the full faith and credit of the United States - collapses. It will set up an economy-wide domino effect. Secretary Geithner explains again, in his letter to Sen. Bennet:
Default would not only increase borrowing costs for the Federal government, but also for families, businesses, and local governments - reducing investment and job creation throughout the economy. Treasury securities set the benchmark interest rate for a wide range of credit products, including mortgages, car loans, student loans, credit cards, business loans and municipal bonds. Accordingly, an increase in Treasury rates would make it more costly for a family to buy a home, purchase a car or send a child to college. It would make it more expensive for an entrepreneur to borrow money to start a new business or invest in new products and equipment.

A default would also lead to a sharp decline in household wealth, further harming economic growth. Higher mortgage rates would depress an already fragile housing market, causing home values to fall. Additionally, a default would substantially reduce the value of the investments - including Treasury securities - held in 401(k) accounts and pension funds, which families depend on for their retirement security. This significant reduction in household wealth would threaten the economic security for all Americans and, together with increased interest rates, would contribute to a contraction in household spending and investment.
So the failure to raise the debt limit will make the debt crisis worse, make it harder for you to buy a house or a car, or to send your kid to college, quite likely collapse your retirement account (both because the Treasury notes in your investment would become less valuable and because thanks to the financial market disaster, the rest of your retirement investments will also go capoot), and for your employer to invest or get financing, which might well result in you getting laid off. Sounds great so far, doesn't it?

But wait, there is more. It's not just a market catastrophe. If the government can no longer finance itself, all of its obligations will suffer -- well, their beneficiaries certainly will. In another letter addressed to the entire Congress, Secretary Geithner also points out the following:
As I have written previously, default by the United States on its obligations would have a catastrophic economic impact that would be felt by every American. A broad range of government payments would have to be stopped, limited or delayed, including military salaries, Social Security and Medicare payments, interest on debt, unemployment benefits and tax refunds.
Playing politics with the debt limit is nothing short of advocating for leaving our troops without pay, leaving our seniors and the most vulnerable without their lifeline, and leaving the middle class straddled.

Let's recap the key points real quick:

  • Raising the debt limit does not authorize new spending. It merely enables the government to pay for current legal obligations.
  • Refusing to raise the debt limit makes our national debt worse, not better.
  • Failing to raise the debt limit will cause the US to default, sending the entire world financial system into a tailspin.
  • A default would raise your cost of buying a house or a car, or sending your kid to college.
  • A default would raise your employer's cost of financing and choke off new business investment, causing a jobs crisis.
  • A default may make your retirement portfolio worthless.
  • Default by the US government would halt pay for our soldiers, Social Security and Medicare payments, unemployment benefits, and even your tax returns.
This is why you should care. This is a serious matter. It is not simply irresponsible for Republicans in Congress to play politics with it, it is downright dangerous. It is putting our very financial system in the face of irreversible ruin - the effects of which will be felt by nearly everyone reading this column. It is literally victimizing ordinary people in order to stoke the egos of grandstanding politicians. Raising the debt limit is the fiscally responsible thing to do. It is vital to the full faith and credit of the United States. And it is vital to protect our economy, our jobs, our social compact, and our families.

If you are interested in additional reading (for say, Debt Limit 102), I recommend: