In the days to come, there will be much debate about the efforts of Congress and the White House to reach an agreement on raising the national debt limit to avoid a potential default of the federal government. The current debt ceiling limit is $14.294 trillion, an amount that was breached back in May. However, by taking evasive actions and “borrowing from Peter to pay Paul,” the U.S. Treasury Department has been able to postpone the day of reckoning until August 2.
If an agreement is not reached to raise the “ceiling” by August 2, the Treasury Department warns that the country will face default. In simple terms, if the government is not able to borrow more money to pay its obligations, the federal government will not be able to make certain payments after August 2. Getting most people’s attention, the government has noted that they may not be able to make certain Social Security payments or other government benefits payments in August (and afterwards) unless the overall debt limit is increased.
Without a doubt, this issue has become a major political “football” and an issue that will serve as political fodder in the upcoming elections.
Much discussion could be had on how we got into this quagmire, with blame placed on all political parties. Further, we could deal with all the fear tactics that are being thrown around about “granny not getting her Social Security check.” We will leave those issues for the local newspaper and media outlets to address.
But more importantly, for participants in the Ministers’ Retirement Plan, will this debate and the ultimate decision impact your investments? The answer is undoubtedly a resounding …… maybe!!!
If so, how? Anytime a government has defaulted or neared such in the past – just recall the situation that Greece found itself in a few months ago and continues to struggle with today, the costs of issuing government debt has increased drastically. That simply means for the government to get others to buy its’ debt instruments (Treasury notes and bonds) it must pay a higher interest rate than it paid before it faced default.
The uncertainty of the debt limit has already begun to impact the financial markets. For example, on June 24 the 10-year Treasury note was paying 2.87% annual return. By the time the markets closed seven days later on July 1, 2011, the same instrument was paying 3.20% – a jump of .31% in just one week. As the day of reckoning approaches, investors are requiring the U.S. government to pay almost a third of one percent more just because of increased risks.
While one could look at the comparison above and conclude that they had much rather have a bond paying 3.20% than one paying 2.87%, it does not take into consideration the fact that the price of bonds moves in reverse of the yield. Therefore, as yield went up on bonds, the price of bonds already in a seasoned portfolio like the Trustees’ Fund went down in value. A rapid rise in bond yields brought about by the risk of, or actual, default of the federal government could wreak havoc on a large bond portfolio of $125 million or so as held in the Trustees’ Fund.
Therefore, we are hopeful that the political leaders in Congress, along with the President, will be able to reach an agreement soon on the debt ceiling. Too much is at stake for our national leaders to play political games at this point.