Lessons from the Most Recent Debt Ceiling Battle

Something that used to be a formality, the Federal government raising the “Debt Ceiling” in recent years has become a political bargaining chip, but one with potentially damaging consequences. Chances are you saw or heard news headlines in recent months about the battle being waged in Congress and the White House about this sensitive issue and the fact that not raising that ceiling could put the U.S. economy at peril. Near the 11th hour, a deal was reached that averted the potential crisis, but in the interim the situation created a lot of nervousness and global impressions that may not be easily changed. The world provides us with so many lessons on a regular basis that we can apply to our personal lives, and the nature of this situation offers a number of cautions and lessons that can be applied to our personal financial management. So, in this issue of the newsletter, we will start with some context about the recently concluded Debt Ceiling situation and then look at 4 lessons we can take away from it for our own financial benefit.

What the Fight Was All About
Since we only tend to hear about the Debt Ceiling when there is a fight about it in government, let’s first explain what the Debt Ceiling is. It is a dollar cap on the amount that the U.S. government can borrow by issuing bonds. That is important because, with the exception of the years from 1998 to 2001, the Federal government has been operating at a deficit since 1970. In other words, expenses incurred by the government have exceeded revenue in 49 of the last 53 years. With that being the case, borrowing money is a way of life for the Federal government to ensure all of its expenses are paid. Therefore, if the Debt Ceiling were to be frozen and new borrowing not allowed, the government would only be able to pay out for expenses that were within the amount of tax revenue generated and would be unable to pay for some obligations that have already been made, including payments on its outstanding accumulated debt. If the government were to default on such obligations, much like an individual’s credit standing would suffer, so would the U.S. government’s credit rating. In fact one of the credit rating agencies, Fitch, put the U.S. credit on a “Rating Watch Negative” in the days leading up to the deadline to finalize a deal and even hinted they may still downgrade their rating after the deal was finalized because this exercise of threatening not to meet our obligations has started to occur with more frequency. If such a downgrade were to happen, that could result in higher interest cost for the U.S. when borrowing money, which would serve to further imperil our ability to meet our obligations. On top of those issues, there was consensus that if the Debt Ceiling were not raised and the government defaulted on its obligations that a recession would ensue, and not limited to the U.S. but globally, with all of the associated pain of job losses that go along with recessions.

Lesson 1: An Unbalanced Budget Makes You Reliant on Debt
The heart of the Debt Ceiling issue is inability to balance the Federal budget because borrowing is not a necessity when you can pay all of your bills from your income. Similarly, with your own household, when you can cover your expenses (obligations and discretionary items) with the income you have available, you don’t have to borrow to meet those requirements. You may still choose to borrow money for the purpose of making more efficient use of your own assets, but you don’t have to do so just to keep the lights on. There may have been a time when the Federal Government had reserves available to absorb current deficits, but after 50+ years of operating in this way, it would be impossible to expect that reserves would cushion us from having to take out debt. Likewise, with our personal finances, having Cash Reserves in savings can help cover for a shortfall in income for a period of time, but that is only going to work for so long. Operating in a way that ensures your expenses don’t exceed your income is your first line of defense in not having to rely on debt to keep you afloat.

Lesson 2: Reliance on Debt Takes Control Out of Your Hands
While it is a commonly held belief that the U.S. is the richest and most powerful country in the world, the fact that we rely on debt to cover our obligations gives our authority a little less weight. While a method of us raising the capital that we need is issuing bonds, the fact is that we also owe money to other countries, and if they wanted to, they could call us on our obligations, and would have a duty to pay them. That may not happen in practice because of our size as a nation. Individuals, on the other hand, may not have the kind of size to be able to withstand a creditor that calls in their debt. As a result, having a debt obligation to a creditor takes some control away from you. Of course all debt is not created equal. If you have taken out debt that is backed by the collateral of an asset of equal or greater value, you can have less concern about being put into an uncomfortable situation should your debt get called in. However, if you need access to debt financing simply to pay your bills, you are putting yourself in a dangerous position.

Lesson 3: Your Credit is a Reflection of Your Good Name Financially
When it comes to assessing reliability on a personal level, we can look at someone’s character and actions to determine the level of trust we feel comfortable placing in them. Assessing financial reliability in an objective way, however, often is largely a function of your credit profile. Other factors may come into play, such as income and assets, but your behavior financially is likely to be reflected in your credit profile. The U.S. government has historically had a stellar credit rating, but as we stated previously, the Debt Ceiling situation caused one credit rating agency to consider downgrading us. In 2011, during a different Debt Ceiling fight, another rating agency, Standard & Poors, dropped our credit rating from AAA to AA+. While the rating is still high, the fact that we could no longer hold that highest of ratings has a reflection on the good name of the Federal government and its image globally. In a similar way, potential creditors and other entities that access your personal credit, will make determinations about you based on the objective data of your credit profile. It may not seem fair, but it is reality, so it is important that you do all that you can to maintain the best credit you possibly can.

Lesson 4: If You Don’t Learn from Past Mistakes, You’re Likely to Repeat Them
Some of the best lessons we can learn come from difficult and painful situations. That is if we put into practice the lessons we learned. The fact that some of our government officials consider the Debt Ceiling as a bargaining chip but don’t consider the other fallout nearly as important would indicate that the turmoil that has accompanied past battles over this issue has not made enough of an impression. Perhaps the past consequences from these battles have not been severe enough to cause a change in behavior. The good news for the U.S. is that we have the capacity to absorb the challenges caused by these fights without being subject to major peril. Depending on your individual circumstances, you may be less able to withstand the consequences that come with some mistakes. So, it is important for individuals to take the lessons we learn, especially the hard ones, and use that information to make better decisions in the future.

Stewardship Emphasis

The Bible tells us that “the borrower is slave to the lender”. If you want to have more firm control of your life, minimize what you owe to others.

The Empowerment Channel |Volume CCXIV | Dedicated to Promoting Financial Education through Stewardship