GO
Loading...

Henes: 5 Things to Know About the Debt Ceiling

The weekend ended with no deal on the debt ceiling.

As I wrote last week, there are at least five reasons why the debt ceiling may not get raised. As we head into this week, the common wisdom remains that the debt ceiling will be raised one way or another.

But will it?

Here are five things to know about the debt ceiling debate.

#1: The Debt Ceiling May Not Get Raised.

We are eight days away from the debt ceiling deadline - i.e., the day that the United States needs to start picking and choosing which obligations to pay and which obligations to stretch out - and there is no deal. In reality, the only deal that can be reached is to temporarily lift the debt ceiling and agree to negotiate, in the future, a debt and "operational" restructuring of the federal government. Questions remain as to whether our leaders in Washington will be able to agree on a short term solution. The Republicans want a balanced budget amendment (to state the obvious, not happening this week); the Democrats want increased revenues (read tax increases); the Republicans will not vote in favor of a plan with tax increases; and the Administration has stated that it will not agree to a short term solution unless it is solely to allow for a long term bill to be passed (in other words, the Administration does not want this debate to happen again until after the 2012 elections). There are a lot of political balls in the air. One may drop and the debt ceiling may stay where it is for the time being.

US Capitol Building with cash
US Capitol Building with cash

#2: The United States Will Not Default.

Let's be clear, the United States will not default on its public debt. It's not even an option. The federal government has sufficient funds to make its interest payments and creditors will roll over debt. Yet, the media and many political leaders continue to equate the failure to raise the debt ceiling with a default. It is not accurate and should be corrected. Holders of United States bonds will get paid.

#3: The United States May Be Downgraded.

The debate over the debt ceiling did accomplish a few things. It highlighted to the ratings agencies that the United States cannot meet its obligations when they become due without borrowing. It highlighted that the United States has a massive debt problem that needs to be fixed. And, it highlighted that political fighting may cause the United States to fail to meet certain of its obligations. Taken together, the United States may be downgraded. Many investors and others say "so what?" They ask whether it really matters. Of course it matters. The United States is supposed to be the most-admired nation both economically and politically. But as the world watches, the United States is a week away from telling certain of its citizens that the check will not be in the mail.

#4: Interest Rates May Not Rise.

In the ironies of all ironies, if the United States does not raise the debt ceiling and starts stretching out its payables, rates may not rise. While the stock market and corporate bond markets will most likely go haywire based on both the shock of our political leaders not reaching some sort of resolution and the concerns over the impact to the economy, in a flight to safety, investors may buy treasuries. Why is this? Because the world knows that at the end of the day (maybe not the end of the day on August 2nd, but at the end of some day), the United States will reach an agreement on spending cuts and tax reform and start putting its fiscal house in order. Consequently, treasuries will be safe investments even as the chaos ensues in the markets while a restructuring plan is debated, negotiated and implemented.

#5: We Are Mixing Apples With Oranges.

By raising the debt ceiling, the United States will not be creating additional obligations. The United States needs to raise the debt ceiling to pay for obligations already incurred. As a result, if the debt ceiling is raised and the Treasury borrows money, which it then uses to pay off existing obligations, the United States is converting an unfunded obligation into a funded obligation. The different plans that the Administration and Congress are proposing relate to future obligations. Specifically, the plans are focused on limiting future obligations and raising future revenue. So, the debt ceiling debate and the debt reduction plans are two different animals that through political maneuvering merged into one. Even if the debt ceiling is not raised now, the United States will need to come up with the money at some point to pay its delinquent obligations.

This week will be interesting to watch. Will sanity prevail?

Jon Henes is a partner in the restructuring group at Kirkland & Ellis LLP where he has led some of the most complex restructurings in the United States and abroad across a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications. Jon has also frequently appeared on CNBC's "Worldwide Exchange" as a guest expert on various financial and economic topics, federal, state and local fiscal issues.

Featured