Treasury Secretary Janet Yellen told top U.S. lawmakers last week that the federal government is expected to hit its ceiling for borrowing this Thursday, with her warning coming as Democrats and Republicans look set for a market-shaking showdown over lifting the limit.
The real trouble could come in the summer. For now, Treasury plans to use so-called extraordinary measures to prevent a U.S. default. Yellen said it's "unlikely that cash and extraordinary measures will be exhausted before early June."
Ahead of the possible fireworks in Washington and on Wall Street later this year, here are some key questions about the U.S. debt limit and answers to them.
What is the U.S. debt limit? Why do we have it?
Congress for more than a century used to authorize each sale of Treasury bonds to pay for specific projects, but U.S. lawmakers gave the Treasury Department more flexibility on the country's debt in 1917, as officials faced the onset of World War I and a federal government that was growing in size.
Then, just before World War II, Congress gave the Treasury almost unlimited power to decide what securities to sell and how to best manage the nation's debt -- subject to an overall limit.
Ever since then, Washington has produced battles over raising the limit on federal borrowing to pay for spending already approved by Congress, with both Republican and Democratic presidents having to cajole a reluctant Congress, as MarketWatch has previously reported.
A New York Times editorial in the 1980s complained that "the fight to raise the debt ceiling is a periodic ritual on Capitol Hill, and every battle is surrounded by predictions of fiscal ruin."
What happens when the U.S. runs up against its debt ceiling?
When the federal government reaches that ceiling, it can't increase its outstanding debt and can only draw from cash on hand, spend incoming revenues and take those so-called extraordinary measures, according to White House economists.
"When the U.S. Treasury exhausts its cash and extraordinary measures, the federal government loses any means to pay its bills and fund its operations beyond its incoming revenues, which only cover part of what is required," the economists noted in a blog post in 2021 -- amid an earlier standoff over the limit.
"While the United States has hit the debt limit before, it has never run out of resources and failed to meet its financial obligations."
In August 2011, lawmakers approved an increase to the debt limit just hours before a potential government default.
But then, within days, the U.S. lost its triple-A debt rating from Standard & Poor's for the first time in history, with the credit-rating agency saying the political system of the world's top economy had become less stable.
What could happen if the U.S. actually defaults?
The words used to describe this possibility tend to be along the lines of "catastrophic" and "unprecedented."
An actual default on Treasurys could mean that investors end up having "lost faith in future payments on U.S. debt," said David Kelly, chief global strategist at JPMorgan Funds, in a note on Tuesday.
"This could have dramatically negative impacts on a wide range of financial assets including U.S. bonds, equities and the dollar . Relative winners, in such an eventuality, could include real assets, high-quality international equities and the government bonds of countries perceived to be more fiscally responsible," Kelly added.
"Financial chaos would, presumably, eventually lead to some compromise in Washington. However, this might not occur soon enough to prevent a recession and could leave some lasting scars, including a permanent increase in the cost of funding U.S. federal debt."
What does the Republican-controlled House of Representatives want?
House Speaker Kevin McCarthy on Sunday reiterated his party's calls to combine cuts to spending with raising the debt limit.
"Why would we sit back and be so arrogant to say, 'No, there's no waste in government?' " the California Republican told Fox News. He didn't offer specifics on cuts, however.
The deal that McCarthy made with some of his Republican critics in early January in order to secure the speakership is said to include a promise to attempt to cap discretionary spending at fiscal 2022 levels, which reportedly could mean reducing defense $(ITA)$ outlays by about $75 billion.
Some analysts have been warning that the rocky process of electing a new House speaker doesn't bode well for how the chamber will handle the debt ceiling, as McCarthy again can only absorb four defections given the slim GOP majority.
What do the Biden White House and the Democratic-run Senate want?
White House press secretary Karine Jean-Pierre said the Biden administration wouldn't negotiate over the debt ceiling and told reporters it should be raised "without conditions."
"This is something that must get done," she said at a daily briefing Friday.
Senate Majority Leader Chuck Schumer and House Minority Leader Hakeem Jeffries, both New York Democrats, said in a joint statement Friday that their party wants to move quickly to pass legislation on the debt ceiling.
"We've seen in previous debt-ceiling standoffs that even the threat of default leads to even higher costs for working families. Republican leaders must do the right thing to protect Social Security, the economy, and our country," Schumer and Jeffries said.
What are the key dates, and what's tax season got to do with it?
The day when the Treasury can't meet all of its obligations and defaults is called the "X Date." Analysts had been predicting it could come in July or August, so Yellen delivered a bit of a surprise with her focus on early June.
In any case, there are some expectations that negotiations over the debt limit won't begin in earnest until after President Joe Biden delivers his State of the Union speech on Feb. 7. There's also chatter that talks might not ramp up until after mid-April, when tax-season hits its peak with income-tax filing day.
The Treasury may be able to extend the X Date if the government takes in more tax revenue than expected this April, said Eurasia Group's Jon Lieber and Kylie Milliken in a note.
The Eurasia Group analysts also said it's unlikely that Congress will be able to develop a long-term solution by June, so lawmakers probably will pass a three- or six-month suspension of the borrowing limit to allow more time to come to a consensus.
"This could turn into a can-kicking exercise that aligns the X Date with the end of the fiscal year on 30 September to create one mega-negotiation over spending. In this scenario, Congress could again punt the debt limit until December, as it did in 2021," they added.
What's the deal with payment prioritization?
Some House Republicans reportedly have come up with a way for the Treasury to prioritize certain debt payments in the event of a default.
But Benjamin Salisbury, director of research at Height Capital Markets, said it's "unclear that the plan would work in practice, and it would need buy-in from the White House and Democrats in the Senate to be enacted, something we view as unlikely."
The prioritization plan could call for the Treasury to continue making interest payments on U.S. debt, as well as to keep making payments on Social Security, Medicare and veterans benefits, as well as funding the military, according to a Washington Post report.
What about the trillion-dollar coin?
Some progressive policy analysts in the past have pushed for the minting of a $1 trillion coin.
In 2013, there was speculation that the Obama administration might mint such a coin, deposit it at the Federal Reserve, and then draw $1 trillion to pay bills if Congress didn't raise the borrowing limit. Former President Barack Obama later acknowledged that he had considered the idea.
Couldn't Democrats have handled this last year when they had control of both chambers of Congress?
As 2022 was winding down, top Democrats privately and publicly discussed the possibility of using what's known as a budget-reconciliation process to hike the debt limit.
However, the Biden White House reportedly gave up hope for that, as senior administration officials saw little chance of attracting any Republican votes for it, and they didn't believe they had the 50 Democratic Senate votes needed for passage via reconciliation.
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