5/3/23 Debt ceiling showdown: 5 possible outcomes

Debt ceiling showdown: 5 possible outcomes

Time is running out on Congress to raise the debt ceiling and prevent the nation from defaulting, a scenario that could destabilize global markets and devastate the economy.

Treasury Secretary Janet L. Yellen told lawmakers Monday that the government could fall behind on its bills as early as June 1 if Congress doesn’t allow it to borrow more money. President Biden called for a meeting of congressional leaders at the White House next week to attempt to resolve the crisis.

The Republican-controlled House narrowly passed legislation in late April that paired a debt limit increase with trillions in spending cuts over the next decade, unwinding many of Biden’s legislative achievements. The president and Senate Democrats, who control the upper chamber, say they will not negotiate on debt limit legislation, demanding an increase without preconditions. Republicans raised the debt limit multiple times during the Trump administration without demands for spending cuts.

The outcomes of failing to raise the debt ceiling are in less dispute, economists say.

The government spends more money than it brings in through revenue, and it issues debt to cover its bills. If the limit on how much it can borrow is not raised, the United States would risk an unprecedented default, leading to a global loss of confidence in federal debt.

That could lead to a stock market crash, driving up unemployment and pushing untold numbers of companies out of business. A recession would be all but assured.

The impasse leaves the country with at least five possible scenarios: Biden and House Speaker Kevin McCarthy (R-Calif.) reach a deal on the debt ceiling; rank-and-file lawmakers make an end run around congressional leadership; Congress passes stopgap legislation to delay a default; the White House acts unilaterally to resolve the crisis; or the United States defaults.

Here’s what each case would mean for the country and economy.

1

Biden and McCarthy make a deal

A deal between the president and speaker would be a positive outcome for financial markets, some experts say, but it would come with economic costs.

Biden and Democrats want a “clean” debt-limit bill — legislation to increase the government’s borrowing authority without preconditions. That would buoy Wall Street stocks and boost consumer confidence, said Chris Rupkey, chief economist at research company FWDBonds.

But lawmakers would have to revisit debt limit legislation again, probably within one or two years. That would mean another round of tense negotiations, possibly even before the 2024 presidential elections.

“Let’s just say the status quo in and of itself is disruptive,” said Mark Hamrick, senior economic analyst at Bankrate.com.

Investors also would cheer a deal if it included GOP-demanded spending cuts, Rupkey said. But spending cuts have their own economic costs.

The legislation passed by the House does not specify which federal programs could lose funding. Lawmakers might have to work that out through a separate budget process.

There would likely be a fierce debate over which federal programs to curb. Democrats have alleged that Republicans want to cut things like Social Security, Medicare and veterans’ benefits. Millions of individuals and households rely on these programs, and cuts could erode consumer confidence and plunge millions of people into economic uncertainty. Many Republicans, though, say they want to leave those programs intact and instead focus on things like education, housing and environmental programs.

The timing of any deal is crucial, said Michael Strain, director of economic policy studies at the American Enterprise Institute, a D.C. think tank. An agreement sooner, rather than later, would prevent a lot of economic harm, he said. Waiting until the last minute would put investors through such a whirlwind that markets will suffer, Strain said.

“I think if we wait until the 11th hour to raise the debt ceiling — even if we raise it in time — that’s a substantial market event,” Strain said.

2

An end run in Congress

Democratic lawmakers have quietly worked for months to set the stage for a long-shot end run around McCarthy and Biden.

Through an arcane device called a “discharge petition,” lawmakers could call a bill to the House floor without the approval of the speaker. That maneuver would require the support of 218 members. A backbench Democrat, Rep. Mark DeSaulnier (Calif.), introduced a bill in January designed for such a purpose.

The odds of success for a discharge petition are slim. The House passed the GOP debt limit bill on a party-line vote. The only Republican defectors were four far-right lawmakers who would not be expected to join a Democratic bill. And a similar measure would need to pass the Senate, which could also be very difficult given how at least one Senate Democrat says both parties should negotiate a deal.

3

A bill to buy more time

Congress could pass a bill to temporarily “suspend” the debt ceiling for several weeks or months to give lawmakers and the White House more time to negotiate a deal.

If lawmakers decided to, they could suspend the debt ceiling until the end of September. That would align a new debt ceiling deadline with another deadline: the budget. Congress must past new spending bills by the end of September, or the government would partially shut down. That would allow policymakers to put all of these issues in one debate, but it would raise the stakes even more if they don’t act.

The odds of this happening, though, don’t appear to be high. Senate Majority Leader Charles E. Schumer (D-N.Y.) told reporters that a short-term extension did not make sense and that he preferred pursuing a debt limit increase that would last for two years.

Neither Republicans nor Democrats, Strain said, want to haggle over the debt ceiling twice in a short span, lest they get blamed for fruitless and protracted negotiations with the economy hanging in the balance.

“They know it’s not going to be any easier to do that in September than it is in June,” Strain said. “In fact, it’s going to be harder. I think that can compel both the Republicans and Democrats to say, ‘Look, we really need to just do this now.’”

Investors would view even a short-term agreement as a much better alternative than a default, Rupkey said.

4

The White House acts on its own

There are a two main options for the Biden administration to act by itself to resolve the debt limit question, although the White House has not said it is considering either scenario.

First, Biden could order the U.S. Mint to create something like a coin worth $1 trillion. The White House could then deposit the coin with the Federal Reserve and use that money to pay the government’s bills. But that poses significant downsides, experts say.

The first is that the Federal Reserve would need to accept the coin, and it’s not clear that it would. Fed Chair Jerome H. Powell told Congress that the coin ploy “would be a rabbit coming out of a hat.”

See how the national debt grew to $31 trillion

The second is inflation. If $1 trillion in new money suddenly appears, the other currency in circulation becomes less valuable. That could hurt consumers, who are already dealing with price inflation.

Some legal scholars believe another alternative is for Biden to simply order the government to keep borrowing money while citing the 14th Amendment of the Constitution. Section 4 of the amendment states: “The validity of the public debt of the United States … shall not be questioned.”

Strain said that invoking the 14th Amendment would be a “reasonable argument” for the White House to make, given a straightforward reading of the 155-year-old text. And while markets would likely get spooked on the news, it would be temporary, he said, because the decision would resolve a larger issue about the future of the debt ceiling.

“I think a world without a debt limit would be a better world,” Strain said. “This would take us to that world.”

That plan also has downsides. It would almost certainly face a legal challenge, Strain said, and could pit one branch of government, the executive, against another, the legislative.

Congress could argue that debt issued by the president’s administration was illegal, and investors would be left to sort out the confusion while the courts deliberated.

“That,” Strain said, “would be a big problem.”

5

The United States defaults

If no deal is reached, Congress doesn’t act, and the White House doesn’t do something unilaterally, it’s likely the government wouldn’t have enough money to pay all of its bills. It would “default” on some of its obligations. There is no precedent for the government missing payments like this.

Parts of the government could shut down, sidelining federal services and delaying or suspending safety net programs. The government would be under tremendous pressure from Wall Street to prioritize payments to debt holders, but that could be a political headache, for example, if the White House authorizes payments to foreign governments that hold U.S. debt before making payments to senior citizens who are due Social Security benefits. Rating agencies would probably downgrade U.S. debt. Interest rates would probably spike.

Rupkey believes that within hours of a default, investment markets would fall between 5 to 7 percent — erasing trillions of dollars in value. Businesses would cut back on investment and lay off workers, Strain predicted, and consumers would pull back on spending.

That would almost certainly shove the economy into a recession, Hamrick said.

“You’d be talking about a large amount of people losing employment and income,” he said.

The swift economic downturn, Strain said, could spur Congress to quick action, and it would give Biden significant leverage to demand a bill without spending cuts. Markets would probably rebound, Strain said, but investors would be chastened. Federal debt underpins vast swaths of the global economy, and the U.S. government, he said, would have just shown itself unable to make good on its obligations.