The US debt ceiling debate is an interesting political sideshow, but just how serious could the actual problem be?What do Americans think?
A recent CBS New poll that asked Americans whether or not the federal debt limit should be raised showed that almost 65% think that it should not be!
Given that result, compare the current federal debt crisisto the potential ramifications for any family USA, a smallindividual borrower who gets a $100,000 loan at a 1%initial interest rate. This 1% is a teaser rate that will be adjusted at some point in the future to a prevailing market interest rate.
The first issue to be faced by this borrower is to jump through hoops set-up by the bank in order to prove that based on current household income and current expenses, this new $100,000 debt would be affordable. At some point in the future however, the interest rate on the loan will reset to whatever the prevailing market interest rate is at that time. That new rate would make this initial income and expense analysis almost irrelevant. This describes basically all of the adjustable rate loans that homeowners have entered into.
If, at the time of the reset, interest rates had moved to 5%, what had been a $1,000 a year interest payment expense would now become $5,000. For many borrowers, this change would be a catastrophic increase and unaffordable, causing either a default on the loan, a move to a bankruptcy filing or both. The last thing that they would be able to do in order to solve the problem would be to borrow more money in order to meet their new obligations.
The federal government faces the same exposure but not the same risk as up until now it has faced no real borrowing limits!
In reality the interest rate reset and interest rate risk is not any different for the federal government than that faced by any family USA. That is except for the fact that the federal government cannot afford its debt now, never had to prove it could and that any move up ininterest rates from here could be devastating for the country! The US Treasury hastreasury bills, notes and bonds that mature and need to be rolled over to fund the government, all of the time. It also needs to float new money debt for additional spending needs and income shortfalls.
The US government, through the actions of the Federal Reserve, has been able to borrow at extremely low interest rates for an extended period of time. These low rates will not be the reality forever. Because it constantly needs to raise more money, the country's deficits and debts keep rising. The interest expense on that debt thus eats up more and more money each year. As a result the government needs to borrow more and more requiring that the debt ceiling be continually raised higher and higher.
This is certainly not possible for ordinary citizens who get shut-off from access to credit at very specific debt to income ratios. It is this national debt and interest expense on the debt that poses a grave risk to the future viability of the country, although it is not a subject that very many people really focus on.
The budget deficits and national debt are however a major concern for our foreign benefactors who buy our paper and who fund our deficits. As the better late than never S&P move to place US debt on creditwatch last week showed, willing buyers may in the future only be found at higher interest rates that may create a domino effect of extremely dangerous proportions! Higher interest expense that leads to higher deficits that leads tohigher borrowing costs and so on and so on until....
This debt ceiling fight in Congress will be the classic between those who refuse to make the tough decisions that might jeopardize their office versus those who actually put the country first! These members putting the country before their jobs will be those in the Congress who will risk re-election later in the hopes of helping to force the country to get its fiscal house in order now!
This video explains it in more detail (H/T Global Economic Trend Analysis here).
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