Breaking Down the Debt-Ceiling Debate
Meg Handley

June 13, 2011

What you can expect if the government doesn't find a middle ground on the debt ceiling

The U.S. government has found itself in the crosshairs of another credit rating agency, as progress on increasing the debt limit continues to stall amid political turmoil.

Moody's Investors Service warned that the U.S. government's AAA credit rating -- the highest rating available -- could be in jeopardy if significant steps aren't taken to resolve the political impasse over the debt limit. The House rejected a debt-ceiling hike in late May, prolonging the budget standoff between Democrats and Republicans.

"The heightened polarization over the debt limit has increased the odds of a short-lived default," the New York-based credit agency said in a release. "If this situation remains unchanged in coming weeks, Moody's will place the rating under review."

Moody's warning comes in the wake of Standard & Poor's decision in April to lower the outlook for U.S. debt to negative.

Some critics accuse lawmakers of using the debt ceiling dilemma as a political bargaining chip in the run-up to the 2012 elections, but if this political game of chicken drags on much longer, the U.S. government and taxpayers could face serious repercussions in the form of increased borrowing costs and an erosion of investor confidence in Uncle Sam's ability to manage its finances.

But how much of the debate is political maneuvering and partisan defiance? U.S. News asked the experts to break down the debt-ceiling debate.

What is the debt ceiling?

The debt ceiling -- currently $14.294 trillion -- is the maximum amount of money the government can borrow to finance existing obligations such as Social Security and Medicare benefits, military salaries, and interest on national debt.

Since 1960, Congress has permanently raised, temporarily extended, or revised the debt limit 78 times, according the U.S. Department of the Treasury.

The government hit the debt ceiling May 16, but Treasury Secretary Timothy Geithner has said the country can avoid default until August 2, at which point the United States will exhaust its borrowing authority and default on its debt obligations.

What happens if the debt ceiling isn't raised before August 2?

At this point, no one knows exactly what will happen, but the Treasury Department would not be able to borrow any more money. That's a problem because the government borrows money by issuing bonds to bridge the shortfall between revenue and expenses. The government would have to stop, limit, or delay payments on outstanding debt obligations, something Geithner has warned would have "catastrophic economic consequences."

Default by the U.S. government could result in "the loss of millions of American jobs," according to the Treasury, and jeopardize the government's reputation as a credible borrower.

"If we fail to make timely payments on time, the world would not enter a cataclysmic disaster," says Richard DeKaser, deputy chief economist at The Parthenon Group, a Boston-based financial services firm. "The bigger issue is what this does to the reputation of the U.S. government. If investors feel that risk associated is greater [with U.S. debt] than [it is with] the alternatives, the U.S. is going to have to compete a little bit."

The U.S. government has enjoyed a relatively unchallenged position as a safe haven among bond investors, but uncertainty about its finances could translate into higher borrowing costs. That means more taxpayer dollars would have to go toward debt service.

While Geithner has imposed an August 2 deadline, experts don't predict a doomsday event. "The question is, how egregiously do they want to 'shuffle the paper' to avoid the consequences," says James Angel, associate professor at Georgetown University's McDonough School of Business. "It's not like August 2 happens and the government is going to shut down. The government can pull all kinds of levers to avoid default as long as there's the political will to do so."

What's the point of the debt ceiling?

In theory, the debt ceiling is meant to help Congress control spending. However, with national elections next year, the debt ceiling debate has devolved into a partisan political game.

"You've got two opposing political parties, each trying to score points before the next election and make the other side look as bad as possible and we, the American public, are going to suffer as a result," says Angel. "The real question is, do we keep paper shuffling or do we bring on Armageddon and bring down the other side?"