So if both parties agree, why not just raise the limit? What is everyone arguing about?
In the past, raising the debt ceiling has mostly been a perfunctory matter. The ceiling has been raised almost 100 times since it was established and has gone from less than $1 trillion in the 1980s to $6 trillion in the 1990s. The most recent time the ceiling was boosted was in February 2010. Legislation to raise the debt limit usually prompts partisan posturing about fiscal responsibility, but little real drama. This time is different.
With the national debt at its highest point in 50 years compared with the size of the U.S. economy, the debate about the ceiling has become entwined in the larger issue about slashing the budget. The budget debate is shaping up around trying to balance two perhaps equally unpopular remedies: sharp cuts to popular government-funded programs and major tax increases. Republican lawmakers say that if they raise the limit they need a commitment from the White House for more spending cuts. The Obama administration has resisted the idea of including spending caps or other budget-process reforms in legislation to raise the debit ceiling, arguing that ensuring the government’s solvency is too important to be held hostage to other issues.
What happens if we don’t raise the debt ceiling but continue to pay interest on our bonds?This is an option known as “prioritization.” The Bipartisan Policy Center released a report attempting to think through how this would work in practice, as it has never been attempted before. The raw numbers are chilling: In August, the federal government would have to cut expenditures by about $134 billion, or 10 percent of the month’s GDP. If it chose, for instance, to fund Medicare, Medicaid, Social Security, supplies for the troops and interest on our bonds, it would have to stop funding every other part of the federal government. The drop in demand, when coupled with the turmoil in the markets and the general financial uncertainty, would undoubtedly throw the economy back into a recession. Also keep in mind that we have to roll over $500 billion in debt that month, and if there was uncertainty about how we were going to pay our bills, it is not clear we could find buyers for our debt at anything less than an exorbitant rate. In this way, “prioritization” could actually increase the deficit.
What happens if we stop paying the interest on our debt? This is too scary to consider for any serious length of time. Treasury securities sit at the base of the global financial system. They are considered so safe that the interest rate on Treasuries is called the “riskless rate of return,” as the market assumes there is no chance of default under any circumstances. Almost all other types of debt — mortgages, credit card, auto loans, business loans, hospital bonds, etc. — are yoked to Treasuries. Almost all major financial players hold substantial portfolios of Treasuries or Treasury-related debt in order to buffer themselves against financial shocks. Consider that the 2007 financial crisis was caused by the market realizing it had to reassess the risk of bonds based on subprime mortgages. If the market has to reassess the risk of Treasuries, the resulting financial crisis will be beyond anything we’ve ever seen in this country.