The Federal Debt Ceiling and Your Finances

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1 Center or American Progress | The Federal Debt Ceiling and Your Finances

The Federal Debt Ceiling and Your Finances

What the Republican-led Effort to Cap the Government’s BorrowingLimit Means for American Families

Christian E. Weller May 2011

Introduction

Tink he pain o he recen run-up in gasoline prices was punishing o your walles and

pockebooks? Ta will be nohing compared o he coss o amilies’ savings and pay-mens on heir debs i Republicans in he House o Represenaives succeed in blocking

an increase in he ederal deb ceiling.

Te discussion over he ederal deb limi is urning ino a poliical showdown wih

America’s nancial sabiliy and amilies’ economic securiy a play. Te U.S. govern-

men is expeced o reach is deb limi—he maximum amoun i can borrow wihou

Congress raising he limi—in a ew weeks. Republican leaders are orceully saing hey

will no raise he deb ceiling or only raise i under condiions ha are exceedingly dam-

aging o he economy and hereore unaccepable o Democraic members o Congress.

Holding he line agains Republican eors o orpedo he nascen economic and labor

marke recovery over raising he deb limi will be criical o he well-being o American

amilies. Failure o raise he deb limi would deliver a serious blow o U.S. nancial

markes. Te sock marke would plunge in a panic due o he uncerainy over he U.S.

governmen’s willingness o pay is bills and consequenly wha ha would mean or he

U.S. economy. Te economy would ake a serious hi.

Once governmen borrowing resumed—as surely i mus as boh paries will evenually

come o an agreemen o run he governmen—lenders o he U.S. governmen would

demand higher ineres raes on U.S. reasuries. Tese higher ineres raes would rickle

hroughou he economy because reasury ineres raes are he benchmark agains

which oher ineres raes, such as or morgages and business loans, are se.

Te upsho: Families would suer immediaely due o subsanial losses in heir reire-

men savings rom lower sock marke prices, and hen would ace higher deb paymens

on heir ousanding deb due o higher ineres raes once he deb limi debae is




resolved. Tese immediae invesmen losses could oal hree o our imes he amoun

o money an average amily paid or gasoline in 2008, he las ime gas prices soared

as high as oday, and higher ineres raes would equal he exra amoun o money he

average amily paid or gas since he beginning o 2011—wih ha exra cos locked ino

place or many amilies or years o come.

So le’s look a litle deeper a he consequences or amilies should Congress ail o reacha deal on he deb limi due o House Republicans’ deerminaion o jeopardize ami-

lies’ economic securiy over raising he ederal deb limi. Te cos o he recen run-up

in gas prices is peanus compared o wha a ailure o raise he deb limi will inic on

American amilies.

Lower retirement funds for households

A subsanial sock marke drop o beween 20 percen and 30 percen1 alongside

an increase o 0.5 percen in ineres raes2

would have severe nancial consequencesor households.

Savings in 401(k) reiremen savings plans specically will drop sharply. Te average

401(k) accoun balance amouned o $58,351 by he end o 2009, according o research-

ers a he Employee Bene Research Insiue and he Invesmen Company Insiue,

rising o an esimaed $66,520 by he end o 2010.3 Almos 60 percen o hese unds

are invesed in he sock marke,4 which means a 20-percen drop would cos savers on

average $7,911, and a 30-percen decrease would oal almos $12,000.

Tis means amilies would lose hree o our imes wha hey spen on gasoline in 2008(in 2010 dollars), he las ime gasoline prices soared as high as hey are oday. Te

losses ha amilies would see in heir reiremen savings could cover heir basic gasoline

spending needs or several years.

Te average reiremen savings accoun balance would all o $58,608 or $54,653,

respecively. Eiher decrease in reiremen savings would se savers subsanially back.

Tey would lose all gains made in 2010 and much o heir gains in 2009, moving hem

urher below where hey were a he end o 2007, when he oal accoun balance

amouned o $68,897 (in 2010 dollars).

Te average saver will probably claw back some o his money as he sock marke over-

came he iniial panic since evenually a deal will be sruck and he deb limi will be raised,

albei possibly wih a delay. Bu he marke may say a litle lower han i oherwise would

have or a long ime since global invesors—banks, muual unds, and pension unds,

among ohers—may become more leery abou invesing in he Unied Saes given he

uncerainy in he nancial markes ha Congress creaed by no raising he deb limi.




Te cos o his uncerainy—less accumulaed wealh upon reiremen—would all on

amilies, many o whom are sill reeling rom he unprecedened sock marke, hous-

ing, and labor marke losses delivered up during he Grea Recession o 2007-2009. For

hose nearing reiremen, he luxury o ime would be los. Tey would no be able o

wai unil he marke recovers, unlike he average saver, and hose near reiremen have

also a lo more money a sake.

Te Employee Bene Research Insiue and he Invesmen Company Insiue repor

ha he average accoun balance or somebody who has had an accoun or 20 o 30 years

and was in heir 60s amouned o $155,662 a he end o 2009. A 10-percen gain due o

beter perorming nancial markes and coninued conribuions could have easily raised

his amoun o $171,228 by he end o 2010. In conras, a 20-percen drop in he sock

marke (assuming ha 45 percen o all savings are invesed in socks) would ranslae ino

a loss o $15,416. A 30-percen sock marke decrease would resul in losses o $23,116.

Tose near reiremen would have o delay reiremen—i hey could amid already high

unemploymen raes and given he anicipaed downurn in he economy i he deblimi is no raised. Or hese near-reirees would have o accep a lower sandard o living

in reiremen, which would mean ewer medicaions, ewer repairs o heir house, and

ewer visis o grandchildren.

The debt burden goes up again

Families’ deb service obligaions include paying down heir principal and paying iner-

es on heir ousanding deb. Te Federal Reserve calculaes he deb service burden

raio—he share o afer-ax income spen on principal and ineres each quarer—ellrom a high o 14 percen in he hird quarer o 2007 o 11.7 percen in he ourh quar-

er o 2010, 5 a decrease abou equal o hree-quarers o amilies’ gasoline expendiures

in he rs quarer o 2011.6 Te drop in he deb service clearly eased some o he many

nancial pressures ha amilies aced in recen years.

wo acors deermine a drop in amilies’ deb service burden. Families pay down deb,

including loan wrie downs due o deauls and oreclosures, and ineres raes all. Daa

or he pas ew years sugges ha a 1 percenage poin drop in he long-erm reasury

ineres rae wen roughly along wih a leas a 1 percenage poin decrease in he deb

service burden.

A higher ineres rae, ollowing a ailure o raise he deb limi, could hus quickly raise

he deb service burden or amilies. Le’s say ha reasury raes immediaely go up by

0.5 percenage poins. Te deb service burden rae would also increase by a leas 0.5

percenage poins, rom 11.7 percen a he end o 2010, or insance, o 12.2 percen,

assuming ha amilies do no pay down deb more quickly or, more imporanly, do no

increase heir borrowing again.




Tis can mean subsanial pain or many amilies. An increase in deb service equal o 0.5

percen o afer-ax income is larger han he gasoline spending increase or he average

amily o he rs quarer o 2011 rom he ourh quarer o 2010.7 And many lower-

income amilies will see much larger and quicker changes in he ineres hey pay han

higher-income amilies since lower-income amilies are more likely o owe adjusable

ineres rae deb, such as credi cards, insallmen loans, and adjusable rae morgages.

Finally, he eec o higher ineres raes could very well linger much longer han he

sock marke drop ollowing Congress’s ailure o raise he deb limi. Higher ineres

raes will reec he new risk associaed wih lending o he U.S. governmen—and

ha esimaed risk will no disappear because he governmen will evenually make is

paymens. Te U.S. governmen will have o raise ineres raes or some ime o atrac

he same amoun o ineres as beore rom invesors seeking o buy reasuries. Higher

reasury ineres raes will raise ineres raes on everyhing else since reasuries serve as

benchmark or oher ineres raes. Everybody in he end may have o live wih higher

ineres raes and heir associaed economic pain.

Conclusion

Te poliical impasse over raising he deb limi would have serious consequences or

amilies i Republicans ake he negoiaions pas he rs deb-limi deadline in he

coming weeks, and especially i hey srech debae ou unil Augus, when he Obama

adminisraion would no longer be able juggle accouns o say curren on he naion’s

deb obligaions. Families’ reiremen savings could see major decreases, which many

savers near reiremen canno hope o recover in ime or reiremen. And amilies, par-

icularly lower-income ones, could quickly see heir deb paymens go up in he wake o higher ineres raes.

Wha may seem like an esoeric debae ar removed rom people’s lives on Capiol Hill,

could in he end become a major seback or amilies’ economic securiy a a ime when

millions o amilies sil l eel remendous economic pressures rom low housing values,

high unemploymen, and rising coss o living. Tis is no way o run U.S. governmen

nances, playing wih America’s nancial sabiliy and amilies’ economic securiy.

Chrisian E. Weller an Associae Proessor a he Deparmen o Public Policy and Public

Afairs a he Universiy o Massachusets Boson, and a Senior Fellow a he Cener or

American Progress.




Endnotes

1 There are no real estimates o how much the stock market will dive, but a drop o 20 percent to 30 percent seems easily in thecards. The S&P 500 dropped by 20.5 percent alone on October 19, 1987 in an ultimately irrational reaction to a series o small erevents, or a total o 30.6 percent in a spa n o three weeks in October 1987. The market also dropped by 15 percent in the threeweeks surrounding September 11, 2011, rom August 31 to September 21, including one week o market closure. And, the mar-ket dropped by 27.5 percent rom September 19, 2008 to October 9, 2008, ollowing the collapse o Lehman brothers. Substantialshort-term stock market losses ollowing unexpected events are clearly possible.

2 And, interest rates or everything rom mortgages to rerigerators and credit cards will go up i the debt ceiling is not raised. Theinterest charged on U.S. government debt serves as a benchmark or the interest charged on all other interest. U.S. government

debt is seen as risk ree, hence other debt has to cost more to compensate lenders or the higher risk. William H. Gross, ounderand managing director o PIMCO, one o the largest bond investment companies in the world, estimated that ailure to raise thedebt ceiling would increase interest rates by 50 basis poi nts, or 0.5 percentage point.

3 Average 401(k) account balances in the crisis pretty closely ollowed the movement o total savings in 401(k)-type plans, whichgrew by 14.8 percent in 2010, according to the Federal Reserve’s Flow o Funds Accounts. An increase o 14 percent brings thetotal account balance to $66,520 at the end o 2010.

4 This includes direct and indirect stock holdings through mutual unds. The total share amounts to 59.5 percent, according to theFederal Reserve’s Flow o Funds, assuming that the share o stocks in mutual unds reects the share o stocks in mutual undinvestments in 401(k) plans.

5 Data taken rom Federal Reserve System, Board o Governors, “Household Debt Service and Financial Obl igation Ratios” (2011).

6 This is the ratio o gasoline expenditures to disposable income or the frst quarter o 2011. Calculation based on data romBureau o Economic Analysis, “National Income and Product Accounts” (2011).

7 This is the change in the ratio o gasoline expenditures to disposable income or the frst quarter o 2011 relative to the lastquarter o 2010. Calculation based on data rom Bureau o Economic Analysis, “National Income and Product Accounts.”

The Federal Debt Ceiling and Your Finances

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