As a week has passed, it seems as though our political leaders are no closer to a resolution – and actually may be even further apart as the August 2 deadline looms. There are several additional factors that have come into play as more discussion has occurred on this issue.
First, it is now the belief of both political and financial leaders that the August 2 deadline is not a hard and fast deadline, but rather a “soft” deadline. Many believe that the U.S. Treasury Department will have an additional 7-10 days to maneuver before a true default would occur. The possibility of a few additional days has given political leaders less reason to move as quickly as initially planned – and most political observers are giving little to no chance that a deal will be reached by August 2. Most of those observers are saying not to expect a deal until it is true crisis time, somewhere around mid-August.
Secondly, some political leaders are emphasizing that even without an agreement to lift the debt ceiling there should be no default. They point out that current tax revenue is more than sufficient to cover the costs of interest owed on debts issued by Treasury. In addition, they note that those revenues are also sufficient to cover Social Security, Medicare and “essential” defense spending such as pay for current service people and most if not all veteran’s benefits. However, government employees would not get paid, federal agencies would have to close, government grants would not get funded, and federal infrastructure projects would have to be stopped, just to name a few. The political leaders who are pushing to stop any increase in the debt ceiling limit contend that if you pay the interest payments on Treasury notes and bonds, no default should occur, regardless of how much other federal spending stops.
Thirdly, other political leaders are pushing for a balanced budget amendment as a condition to raising the debt ceiling. According to one analysis, going to an immediate balanced federal budget would entail spending cuts of approximately 44% versus planned expenditure. This sounds like a huge reduction – and it is. Still, it would basically take us back to the spending levels of 2004-2005.
Fourth, Moody’s, the bond rating agency, announced this week that there was a greater than 50% chance that they were going to “downgrade” the AAA bond rating on U.S. Treasury bonds and notes if an agreement was not reached soon. While this did not come as a surprise, seeing that two other rating agencies had already threatened such action, it does raise the issue that if a downgrade occurs, the world’s only “risk free” asset – Treasury bonds and notes – may be no more, at least their “risk-free” status would be no more. Further, a downgrade would also most likely bring about an increase in borrowing costs to the federal government, even further adding to the deficit problems we are in now.
As we noted last week, time is running out for an agreement to be reached. Our prayer is that God will give our leaders direction to make the right decision for our great country.
Stay tuned for more information as this crisis-in-the-making unfolds.
(Note: Some of the numbers used in this article were taken from a commentary published by Wells Capital Management.)