Is the Debt Ceiling Made of Glass?

You're about to hear a lot about the debt ceiling--namely, that the limit could be breached as soon as May 16, and the consequences are dire if Congress doesn't raise it. But let's start with what, exactly, the debt ceiling is: the legal limit on borrowing by the federal government. Currently, that limit is $14.3 trillion. If the limit is not increased, borrowed funds would not be available to pay bills, and the U.S. may be forced to default on its debt obligations.

That scenario is unlikely. Treasury has never been unable to make payments as a result of reaching the debt limit. Congress has raised it nearly 100 times since the ceiling was established (in 1917), most recently in February 2010. In the 1980s, the debt ceiling was less than $1 trillion. By the 1990s, it was $6 trillion. Now, it's more than double, and just as the national debt is the highest in 50 years.

You might be asking: what happened? Well, no matter what pours forth on the House and Senate floor these days, neither major party has helped much. Under George W. Bush, the national debt popped to $4.36 trillion (i.e., the cost of wars in Iraq and Afghanistan and new tax cuts), and under Obama there's been an additional $3.9 trillion (i.e., the economic stimulus and decreased tax revenue because of the recession).

All of this leaped in significance yesterday when S&P changed its outlook on the U.S. from “stable” to “negative” and warned that its AAA rating was in jeopardy if officials failed to bring spending in line with revenue. The AAA rating has helped the U.S. to borrow at cheap rates to finance its government operations--including two wars and Medicare and Social Security.

While the Economist yawns, "Writers are going a little crazy over something that's not, actually, news," the Wall Street players are fretting, mostly over the Big Question: What to Do?

Jamie Dimon of JP Morgan Chase recently warned the US Chamber of Commerce, ""If anyone wants to [cap the debt ceiling], which I think would be catastrophic and unpredictable, I think they're crazy."

He went even further on PBS, describing the scenario as he sees it: "Now, here's what really would happen. Every single company with treasuries, every insurance fund, every -- every requirement that -- it will start snowballing. Automatic, you don't pay your debt, there will be default by ratings agencies. All short-term financing will disappear."

The budget bullet will have to be bit by both (try saying that six times) the Congress and the public--if not now, then soon, what with Medicare teetering on the brink. But what that means for the S&P rating?

Felix Salmon of Reuters writes, "If US Treasury bonds aren’t risk-free, then nothing is risk-free, and the triple-A bedrock on which the S&P ratings apparatus is built crumbles away."

And Karl Smith, assistant professor of economics at University of North Carolina Chapel Hill, points out, "A downgrade of the United States doesn’t make any sense. Credit is risky or secure only in relation to other credit and only in certain 'states of nature' as economists like to call it."

From Mothers Against Debt: [youtube][/youtube]