Fitch Ratings said on Wednesday that it will keep a watch on U.S. debt for a possible downgrade if the debt ceiling isn’t raised by August 2. The news was published in the Associated Press yesterday.
Though the government hit the debt ceiling on May 16, it still has buffer time till August 2, to avoid defaulting on its payment obligations.
The rating agency expects the debt ceiling to be raised during the buffer time. If the government fails to do so, the nation will default on its obligations, which would threaten whatever little economic stability the world has seen since the financial meltdown as the U.S. happens to be the largest borrower and issuer of the reserve currency, the agency said.
A lower rating would make it difficult for the country to stand hat in hand before other nations. Investors would demand higher yields to offset the risk associated with lower rated Treasury debt.
As a result, the cost of borrowing for consumers and businesses would increase. Finally, America would land up in a serious debt crisis, perhaps akin to Greece, Mexico and Argentina, which are still struggling to even out.
Not only Fitch, Moody’s Investors Service, a division of Moody’s Corp. (MCO) also said last week that it might start reviewing the credit rating of the country next month. Further, in April, Standard & Poor’s lowered its long-term outlook for the fiscal health of the U.S. to “negative” from “stable.”
House Bars Debt Ceiling Raise
To make matters worse, House overwhelmingly rejected the bill to raise the current $14.3 trillion federal debt ceiling by another $2.4 trillion in a vote staged by Republicans on May 31. The vote was meant to force President Obama to concede to deeper spending cuts.
Two-thirds majority was required to pass the bill. However, as expected, with no spending cuts mentioned in the bill, the result was 318 Nay-97 Yea, without a single Republican vote.
President Obama and Republicans share the belief that the annual deficit of the country needs to be reduced. However, they disagree on how to go about doing it. Republicans want to solve the problem with spending cuts, while the Congress insists on increasing taxes as part of the plan.
The Congress also wants lower scale spending cuts to keep economic recovery in force. So, the future of debt ceiling still remains uncertain.
The Core of the Matter
What is the debt ceiling? It is an upper limit on the amount of debt the federal government can borrow to operate economic activities of the country. A law for debt ceiling was passed by the Congress in 1917 to simplify access to funding.
The primary purpose for setting the debt ceiling is accounting assessments, required to control the budget deficit. Based on policies and related costs, the government settles on the amount it needs to borrow for a given period. Accordingly, it sets the debt limit, which theoretically keeps spending in check.
According to the Congressional Research Service, the debt ceiling has been raised 74 times since March 1962. The ceiling was last set at $14.3 trillion in February 2010.
What’s the Risk?
If the ceiling isn’t raised during the buffer time, the authority would be precluded from borrowing any more funds. Then, the country, which is already head over heels in debt, would be in a fix. Funding its operations and paying creditors would then be out of the question. The rippling effects of lapsing loan obligations would ultimately push the country back into recession.
Almost all the listed U.S. companiesincluding major banks like JPMorgan Chase & Co. (JPM), The Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), Citigroup Inc. (C) and Bank of America Corporation (BAC) would lose access to markets and investors if the debt ceiling isn’t raised.
Is There a Feasible Way Out?
Though the debt ceiling bill did not gain two-thirds majority, the government is probably left with a one and only way to keep the country solvent — to raise the debt ceiling at the earliest. So, raising the ceiling now depends on the course of action the Congress and Republicans settle on to cut spending.
Raising the debt ceiling would stall the rating downgrade that Fitch and other rating agencies are contemplating. But this would only save the country’s face value temporarily.
If we do a quick recap, lifting the debt ceiling will once again clear the economic mess resulting from the debt issue for the next few years. This is just an immediate solution. After a period of time, this will again raise concerns related to debt escalation instead of providing a debt solution.
Finding a long-term solution to the debt issue is no mean task, considering the state of economy. It requires balancing of fiscal policy measures, without which the country will have no other option but to raise the debt ceiling. What is needed now is a gradual implementation of a strategy to take the debt load off the country.
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