What happens if we hit the debt ceiling

Lawmakers on Capitol Hill are on the clock to increase how much money the federal government can borrow. If they don’t, analysts say the U.S. economy, financial system, retirement checks, tax credit payments — and American livelihoods — could be at stake, at least temporarily.

For centuries, the U.S. has spent more money than it takes in. The Treasury Department finances that extra spending by selling government securities. Yet, lawmakers don’t just hand the agency a blank check. Instead, Congress has limited how much the Treasury Department can borrow, so it can pay for the programs it’s legally obligated to fund: from Social Security and Medicare, to military salaries, tax refunds, national interest payments and more. That guideline is known as the “debt ceiling.” Think of it like the credit limit on a credit card.

But unlike what happens when you use up your credit line, Congress isn’t cut off from spending once it reaches that limit. Lawmakers can keep committing to new spending, after which the debt ceiling isn’t automatically raised.

“It has failed miserably,” says Mark Hamrick, Bankrate senior economic analyst and Washington bureau chief, referring to the debt ceiling. “It is akin to having me promise to pay you dollars, and then raise the threat of failing — or fail — to make good on that without funds.”

To address the issue, Congress has to vote to raise or suspend the limit. Lawmakers haven’t been shy of doing that 98 times before in U.S. history, according to the Congressional Research Service.

But what makes this situation more dire is how close lawmakers are to running out of time — and how deeply divided they remain. The U.S. hit its debt ceiling on Aug. 1, 2021, after a suspension from 2019 expired. Since then, the Treasury Department has been deploying “extraordinary measures” to meet those obligations and prevent default, but Secretary Janet Yellen told lawmakers on Tuesday that the government will run out of cash to pay its bills on Oct. 18.

Congress on Thursday passed a bill to avoid a government shutdown, but lawmakers haven’t yet addressed the looming deadline. The Senate on Monday was a few votes short of passing a bill that would’ve suspended the debt ceiling, a protest likely traced to the massive $3.5 trillion infrastructure package that’s currently working its way through the House of Representatives.

This is going to be an eleventh-hour situation. It’s Cinderella running down the stairs as the clock strikes 12.

— Gary Schlossbergglobal strategist at the Wells Fargo Investment Institute

If the debt limit isn’t raised and the U.S. defaults, Yellen has said there could be “catastrophic economic consequences,” with borrowing rates on things like credit cards, mortgage rates and auto loans skyrocketing. Much worse could be another financial crisis.

Here’s how your wallet could be impacted if Congress fails to raise the debt ceiling — including if it defaults.

1. Government obligations such as Social Security and Child Tax Credit (CTC) payments could be paused

If the debt ceiling binds, the Treasury Department might decide to delay — or even temporarily halt — payments to millions of Americans and agencies.

That could be anything from Social Security checks, advance Child Tax Credit (CTC) monies, Medicare disbursements to health care providers, as well as payments to agencies, troops, state and local governments and contractors.

That was at least part of the Treasury Department’s contingency plan published during the 2011 debt ceiling standoff, according to Louise Sheiner, policy director for the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. The agency wanted to prioritize making interest payments and avoid default.

“The Treasury market is viewed as the most liquid and the safest in the world, and it’s a huge benefit to the U.S,” she says. “The idea that you would undermine those benefits and undermine the whole financial system of the world, which depends on Treasurys to operate, has much larger complications for the economy, than, what at the beginning, is a few days’ worth of delays in [entitlement] payments.”

The Treasury Department so far hasn’t released a contingency plan for the 2021 stalemate, but Yellen implied in a Wall Street Journal op-ed from Sept. 19 that the protocol could be the same.

“In a matter of days, millions of Americans could be strapped for cash,” she wrote. “We could see indefinite delays in critical payments. Nearly 50 million seniors could stop receiving Social Security checks for a time. Troops could go unpaid. Millions of families who rely on the monthly child tax credit could see delays. America, in short, would default on its obligations.”

2. Buying a home, car or credit card borrowing could get more expensive

The federal government is able to borrow at a relatively lower interest rate than other governments in the world because Treasury securities are viewed as a safe and liquid investment. The U.S. has never defaulted on any of its debts and managed to cover all of its bills — even if that’s just through approving more borrowing.

Once that view is upended, however, investors might demand a higher premium to protect themselves from risk. Leading up to the event, they could start dumping Treasury securities out of fear that the U.S. government might not be able to pay them back. Any Treasury security sell off would cause yields to rise, bringing up borrowing costs on a wide array of loans, from the mortgage rates that are directly tied to the 10-year bond, as well as credit card and auto loan rates.

“It’s economic disruption,” says Scott Clemons, chief investment strategist and partner at Brown Brothers Harriman. “If you were in the middle of trying to get a mortgage, it would be more expensive to accomplish that. If you’re a small business trying to get a loan, it would be harder. When I’m not sure what the Treasury market is going to do, it makes it really hard for me to lend money because of all of the uncertainty.”

Those consequences could prove to be long-lasting, especially if the fear of another default remains in the back of investors’ minds. Higher interest rates wouldn’t just make the U.S. a more expensive place to live for Americans but could also make both new and outstanding debts costlier.

“It’s kind of a red line in economics,” Clemons adds. “There aren’t that many countries on the face of the planet that have never defaulted on a government obligation, and it’s not the kind of list you want to be on. You don’t want to be on the list with Argentina and Russia, and we could be days away from that.”

3. Stock prices could sink, threatening companies’ bottom lines

If the debt ceiling were to bind, markets would likely whipsaw, potentially enduring immediate and steep losses that might take a while to recover — even if the situation is quickly addressed.

From April to August 2011, at the height of a similar debt limit debacle, the S&P 500 tanked 31 percent. By the end of that year, the index only recovered half of the ground that it lost.

All of that could threaten corporate profitability, and firms that have increased exposure to government spending might take an additional hit. Those could be firms that have contracts with the federal government, as well as insurance firms that derive a certain portion of their revenue from Medicare payments.

“As with the previous experience, if the U.S. were to flirt with default or even enter that mode, it would be appropriate to expect another sharp downturn in stock prices among other negative developments in financial markets,” Hamrick says.

4. The government could default on its debt — but experts say it isn’t inevitable and would (hopefully) be short-lived

The obvious concern with failing to raise the debt ceiling is that the government could default on its debts, meaning it isn’t able to make interest payments or pay back Treasury investors when their bonds mature. The country’s credit rating would likely also take a hit.

Experts say default isn’t necessarily inevitable if lawmakers don’t act by Oct. 18, especially if the Treasury Department can shuffle around money for long enough by delaying entitlement program payments. But if it does happen, the event would likely be very short-lived.

“I don’t think anyone seriously doubts our ability to meet our obligations,” Schlossberg says. Instead, it’s all about “willingness to pay,” he adds.

5. Default could trigger a recession, meaning job losses and income disruptions for millions

That’s not to say that default wouldn’t have massive consequences, even if it was quick. Experts describe default as having a ripple effect. Investors who aren’t paid back by the federal government might then be hard-pressed to fund their own obligations, with the circle getting bigger and bigger.

“Even if short-term, a default would provide a remedial course in global economics at a very hefty tuition,” Clemons says. “The U.S. Treasury market is like the circulatory system of the global economy.”

Even on an individual consumer level, Americans might not be able to afford basic necessities if some form of income comes from the federal government. Demand could take a hit, and with company profitability already in question, hiring could hit a wall as well.

Simulations from Moody’s Analytics showed that default could cost 6 million jobs and push up unemployment to 9 percent.

The Fed, the typical first responder in a recession, also has its hands tied, with borrowing rates already at rock-bottom after the coronavirus pandemic.

That’s a crisis that “would be entirely man-made,” Hamrick says, “meaning also that it would be unnecessary and hugely counterproductive. It is worth a reminder that we have yet to restore the economy to its pre-pandemic condition in terms of employment and many other metrics. So, this would be adding further financial insult to injury.”

Even if the debt ceiling is raised in time, Americans could feel financial pain

Even if Congress fails to act, analysts point to other unconventional fixes to avoid default, such as the Treasury minting and delivering to the Fed a $1 trillion coin or enlisting the U.S. central bank to buy vulnerable debt.

Yellen on Thursday said she supported erasing the debt ceiling altogether.

Experts say they’re expecting Congress to make a last-ditch effort to raise the debt ceiling and avoid default, as has always been the case in the past. But even then, Americans might not go entirely unscathed.

During a similar 2013 debt ceiling standoff, yields on the Treasury securities that were nearing maturity rose between 21-46 basis points, in addition to stock markets experiencing volatility, according to a Fed analysis. The average 30-year fixed rate mortgage in the U.S. climbed nearly 124 basis points in the year, according to data from Freddie Mac.

Americans looking to backstop their finances will want to make sure they focus on building up an emergency savings, even if it means cutting back on discretionary spending to free up some cash. Investors will want to take a long-term mindset and not overreact to short-term events in Washington that hope to be resolved.

Bottom line

However, what happens to the U.S. economy — and your wallet — depends on how long the stalemate lasts, whether the U.S. defaults and how long that default persists.

“Clearly, not raising the debt ceiling is a bad thing for the economy, but there’s a lot of uncertainty — if this actually happened — of how it’s going to unfold,” Sheiner says. “Some scenarios are worse than others. None are good.”

Learn more:

• Survey: A year and a half into the pandemic, Americans say COVID is still economy’s biggest threat
• Will the Fed raise interest rates in 2021? Here’s what experts are saying
• 5 surefire signs of a stock market bubble

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