Why Is the Debt Ceiling Back in the News — and Should I Care?

The U.S. government has hit the debt ceiling, which means within a few months it won’t be able to pay its bills unless Congress votes to raise the debt limit. The U.S. Treasury can keep everything afloat for only a short time before the government defaults, which could spell disaster on a national and global scale. The clock just restarted for Congress to take action.

So, what is the debt ceiling anyway? And why should you care?

The debt ceiling, also known as the debt limit, is the total amount of money the United States government can borrow so it can meet its legal obligations. Those obligations include funding for things like Social Security, Medicare, military salaries, interest on the national debt and tax refunds.

The United States hit its debt ceiling on Jan. 19. 

When the government hits the debt ceiling, it risks eventual default, which would kick off a financial crisis. To avoid a debt ceiling crisis, Congress can raise or suspend the debt limit; the limit has been modified 20 times since 2002.

The U.S. debt ceiling was last increased to $31.4 trillion on Dec. 16, 2021. 

The last time the U.S. hit the debt ceiling was in 2011, and it resulted in a standoff between Democrats and Republicans, which led to chaos in the markets. Default was narrowly avoided by a midnight deal to raise the limit, but the ripple effects on the economy lasted for months.  

In order to prevent the United States from defaulting, the Department of the Treasury is implementing “extraordinary measures” that, for now, primarily impact retirement funds. These measures include:  

1. Redeeming existing and suspending any new investments of retirement funds for government employees, including the Civil Service Retirement and Disability Fund, or CSRDF, and the Postal Service Retiree Health Benefits Fund, or Postal Fund. 

2. Suspending reinvestment in the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan, or G Fund. 

In a Jan. 13 letter, Treasury Secretary Janet Yellen called on Congress to increase or suspend the debt limit. She wrote that the Treasury estimates the government will run out of money and default by June.

Congress usually agrees that raising the debt limit, and thereby repaying the government’s debts, is necessary, and routinely votes for it, as they last did in 2021. However, this time it won’t be so easy. 

Republicans are reportedly demanding cuts to future spending in exchange for increasing the debt ceiling. House Speaker Kevin McCarthy, R-Calif., has asked for discussions to begin. Again, negotiating in order to raise the debt ceiling is unusual. And Democrats aren’t budging on their call to raise the debt ceiling sans strings. On Jan. 18, White House Press Secretary Karine Jean-Pierre said at a press conference, “We have been very, very clear about that. We are not going to be negotiating over the debt ceiling.”

If the default lasts for weeks or more, rather than days, it could trigger a fire-and-brimstone, Armageddon-level financial crisis for the U.S. and global economies.  

A report from the White House Council of Economic Advisors in October 2021 warned of the possible effects of the U.S. defaulting, which include a worldwide recession, worldwide frozen credit markets, plunging stock markets and mass worldwide layoffs. The real gross domestic product, or GDP, could also fall to levels not seen since the Great Recession. 

The U.S. has only defaulted once, in 1979, and it was an unintentional snafu — the result of a technical check-processing glitch that delayed payments to certain U.S. Treasury bond holders. The whole affair affected only a few investors and was remedied within weeks.

But the 1979 default was not intentional. And from the point of view of the global markets, there’s a world of difference between a short-lived administrative snag and a full-blown default as a result of Congress failing to raise the debt limit.

A default could happen in two stages. First, the government might delay payments to Social Security recipients and federal employees. Next, the government would be unable to service its debt or pay interest to its bondholders. U.S. debt is sold to investors as bonds and securities to private investors, corporations or other governments. Just the threat of default would cause market upheaval: A big drop in demand for U.S. debt as its credit rating is downgraded and sold, followed by a spike in interest rates. The U.S. government would need to promise higher interest payments to justify the increased risk of buying and holding its debt.

Here’s what else you can expect to see if the U.S. defaults on its debt. 

A default could provoke a sell-off in debt issued by the U.S. government, considered among the safest and most stable securities in the world. Such a sell-off of U.S. Treasurys would have far-reaching repercussions.

Money market funds are low-risk, liquid mutual funds that invest in short-term, high-credit quality debt, such as U.S. Treasury bills. Conservative investors use these funds as they typically shield against volatility and are less susceptible to changes in interest rates. 

In the past, investors have sold out of money market funds when the U.S. ran up against debt ceiling limits and signaled potential government default. Yields on shorter-term T-bills go up because they are impacted more compared with longer-term bonds, which give investors more time for markets to calm down. 

In the event of a default, federal benefits would be delayed or suspended entirely. Those include:

Social Security; Medicare and Medicaid; Supplemental Nutrition Assistance Program, or SNAP, benefits; housing assistance; and assistance for veterans. 

A default would likely trigger a downgrade of the United States’ credit rating — the S&P downgraded the nation’s credit rating only once before, in 2011 when it was approaching default. The default combined with the downgraded credit rating would in turn cause the markets to tank, the White House’s Council of Economic Advisors said in 2021.

If current debt ceiling talks continue for too long, the markets are likely to become more volatile than they already are.

As debt ceiling negotiations linger, Americans could see rates increase on consumer lending products, including credit cards and variable rate student loans. 

Credit lenders may have less capital to lend or may tighten their standards, which would make it more difficult to get credit. 

Depending on the timing of a default and how long the effects are felt, rates could increase on new fixed auto loans, federal or private student loans and personal loans.

If the debt ceiling isn’t raised, it could take more time for tax filers to receive their refunds — usually within 21 days of filing. If the government defaults, those who file late run a risk of not receiving their refund.  

A debt ceiling crisis won’t impact those with fixed-rate mortgages or fixed-rate home equity lines of credit, or HELOCs. But adjustable-rate mortgage, or ARM, holders may see rates rise even further than they already have — more than four percentage points on rate indexes since spring 2022. Those in the fixed period of their ARM can expect to see rates rise when reaching their first adjustment.

If the government defaults, rates on new mortgages would probably rise, but it’s unclear in which direction variable-rate HELOCs would move.

The debt ceiling and the national debt aren’t the same, but they relate to one another. The debt ceiling is the total the government is allowed to borrow before it defaults. The national debt — $31.41 trillion as of Jan. 19 — is the total amount of outstanding money that is currently borrowed by the federal government, plus interest. Refusing to vote to lift the debt ceiling would not bring down the national debt — it would mean the government cannot repay the debt it already has.  

Here’s how the national debt works: When spending surpasses revenue in a fiscal year, the government runs a budget deficit. In order to pay the deficit, the federal government borrows money by selling what are known as marketable securities, such as Treasury bonds, bills, notes, floating rate notes and Treasury inflation-protected securities, or TIPS. The total debt includes both the amount borrowed plus the interest that it promises to those who lent money by purchasing those marketable securities.