Congress will gain some extra time in saving the U.S. from hitting the debt ceiling as the Treasury is on the verge of taking extraordinary measures, Reuters reported today. Among other actions, the Treasury is expected to temporarily suspend investments in federal pension funds to free up money to enhance the country’s borrowing ability, the source said.

An immediate action was necessary to allow the government some time to protect the country from defaulting on its obligations. As a result, the Treasury was forced to initiate its extraordinary measures last Friday. As of that day, the government’s debt remained just $23 billionshy of the ceiling.

We understand that government spending in the form of several stimuli was a prerequisite for the country’s financial stability. However, these initiatives should not have been taken at the cost of mounting national debt. The government should have taken additional policy measures to control spending and resist deterioration in budget deficit.

However, this temporary arrangement of halting investments in pension funds and redeeming some investments, gives the country a buffer time till August 2, to avoid defaulting on its payment obligations.

The What, Why and When of Debt Ceiling

What is the debt ceiling? It is an upper limit on the amount of debt a federal government can borrow to operate economic activities of the country. A law for debt ceiling was passed by Congress in 1917 to simplify access to funding.

The primary purpose of 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 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 U.S. hits the debt ceiling, the authority would be precluded from borrowing any more fund. Then, the country, which is already neck-deep in loans, would be in a fix. Funding its operations and paying creditors would become unfeasible. The ramification of lapsing loan obligations would then malign the domestic environment and spread the condition internationally.

Almost all the listed U.S. companies, including 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 country touches its debt ceiling.

Additionally, this would pull down America’s credit rating, making it difficult for the country to continue borrowing money from other nations. America would face a serious debt crisis, perhaps akin to Greece, Mexico and Argentina, countries that are still struggling to even out.

Treasury’s Backup Plan

Treasury’s action to push back the date of hitting the debt ceiling include suspending sales of government securities, plummeting some pension funds and accessing the exchange stabilization fund.

Let’s take a quick look at the department’s extraordinary measures:

  • On May 6, the Treasury halted sales of State and Local Government Series securities
  • The department will suspend investments in the Civil Service Retirement and Disability Fund, a government employee pension fund on May 16. This would initially free up about $12 billion in borrowing ability
  • On June 30, Civil Service Retirement and Disability Fund’s $67 billion securities will mature. The Treasury intends to halt reinvestment of this amount
  • On May 16, the Treasury will suspend the reinvestments in G-Fund, a federal employee pension fund. This will free up about $130 billion
  • The Treasury is also expected to consider $50 billion in currency stabilizing fund
  • The department could also stay away from issuance of longer-term government debt and depend more on short-term cash management bills
  • The Treasury will also suspend savings bonds, sell assets and use proceeds from initial public offerings IPOs of some bailed out institutions

The Expected Outcome

Once the extended period is over, it is almost certain that Congress will read the warning and raise the debt ceiling prior to knocking it. Going by past records, this should solve the economic mess related to the debt issue for the next few years.

However, in order to gain Republican support, the government will have to figure out some spending cuts, which will again moderate the efficacy of its stimulus packages.

Is There Any Stable Way Out?

The Congress can only buy time through some short-term measures, but there is probably no long-term solution to the debt issue. Without balancing fiscal policy measures, the need for raising the debt ceiling will automatically increase.

Though we don’t know how high the ceiling can be, raising it will definitely give the government the elbow room to continue borrowing. But it will raise concerns related to debt escalation instead of providing a debt solution. Instead, paying down the debt or spending less would be more practical way outs.

 
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