WASHINGTON — Congress is at an all too familiar stalemate over raising the federal debt ceiling, worrying bankers and others that the financial markets could take a hit if lawmakers fail to reach a deal in advance of an October deadline.
Treasury Secretary Janet Yellen told lawmakers this week that the Treasury Department will
But Democrats and Republicans are effectively playing a game of political chicken. Many expect Democrats will ultimately resolve the impasse on their own. But the closer Congress gets to the deadline without a solution, the worst-case scenario for banks could be higher interest rates, a reduced credit supply and a hit to Treasury securities.
“If it were to truly look like this has gotten out of hand, and it's unlikely to be resolved anytime soon, then I think that's when we would experience the rate rises and credit crunch in the economy,” said William Luther, director of the Sound Money Project at the American Institute for Economic Research.
Several trade groups, including the American Bankers Association, the Bank Policy Institute and the Financial Services Forum, sent a letter Sept. 13 to congressional leadership, urging them to raise the debt ceiling “without delay.”
“U.S. Treasuries are vital investments for Americans and other investors around the world because they are considered the safest and most liquid assets, backed by the full faith and credit of the United States government,” the letter said. “Financial market participants, corporates, states, and municipalities also rely on U.S. Treasuries for risk hedging, transaction collateral, and short-term investments.”
Yellen has also reached out to the CEOs of the country’s largest banks, including JPMorgan Chase, Citigroup, Bank of America and Wells Fargo, to ask for their help in pressuring lawmakers to raise or suspend the debt limit, according to Bloomberg News.
Her warnings this past week to members of the Senate Banking Committee and House Financial Services Committee were dire.
"It is imperative that Congress swiftly addresses the debt limit. If it does not, America would default for the first time in history. The full faith and credit of the United States would be impaired, and our country would likely face a financial crisis and economic recession," Yellen said in testimony Tuesday to the Banking Committee.
Some, however, believe it is unlikely that the U.S. would ever default. Republicans have refused to back measures to lift or suspend the debt ceiling in the Senate, where at least some GOP support is needed. But Democrats could include a debt ceiling hike in their $3.5 trillion reconciliation bill, which can pass the Senate with a simple majority.
Suspending the debt limit historically has been done on a bipartisan basis, but Republicans are arguing that because Democrats have the majority in Congress, they should be responsible for passing a bill to raise the ceiling.
If the U.S. were to default on its debt obligations, it would spell trouble for financial institutions because of the “inextricable link between the fortunes of banks and the economy,” said Ed Mills, a policy analyst at Raymond James.
“When we are dealing with something that could have a huge impact on the economy, the banking sector is a clear place that you would look to pivot,” he said. “They're kind of the first line of who would be impacted from a business perspective, if we were ever to default on our debt.”
In addition to raising borrowing costs, failing to raise the debt limit could also mean that the value of Treasury securities might plummet, which would be particularly disruptive for banks, since many own a large volume of Treasuries and are encouraged to do so under the Federal Reserve’s capital requirements.
Democrats argue that Republicans should band with them to raise the debt ceiling, in part because the limit needs to be raised to pay for previously enacted legislation, such as the bipartisan Coronavirus Aid, Relief and Economic Security Act and the 2017 tax reform legislation that was enacted under former President Donald Trump.
“It's entirely not uncommon to have the party out of power flex their muscle to make sure that their priorities are put in place,” said Chris Campbell, former assistant secretary of the Treasury Department for financial institutions and chief strategist at Kroll, a corporate consulting firm.
“All that being said, there are mechanisms that can be used from the party in power — especially when one party dominates D.C. like the Democrats do today — that allows for that one party, which is, again, today the Democrats, to address the debt ceiling in a reconciliation package,” he said.
A similar situation played out in 2011, when House Republicans refused to pass a bill to raise the debt limit unless the Obama administration cut spending. That spat even led the S&P to downgrade the credit rating of the United States for the first time and sent financial markets into disarray.
That incident, and the similar standoff Congress is currently experiencing, has put big businesses and banks on high alert.
“Having the dollar be dominant, having interest rates remain low and having people have faith in the U.S. dollar is something that is incredibly important to the overall economy and certainly any major business,” said Campbell.
Yellen recalled the 2011 episode in testimony to House members on Thursday.
"When the debt ceiling was raised at the absolute last minute, and investor and consumer confidence was shaken in the run-up, we saw a marked increase in interest rates, a marked drop in the stock market," she said. "And when U.S. interest rates go up, and the credit rating of the United States is downgraded, that means higher interest payments for everyone who has a loan, whether it's a small business, a homeowner with a mortgage, a credit card payment. Anyone who borrows would see higher interest costs of their debt."
Yet today’s fight over the debt limit is much different from the 2011 impasse, given that Democrats control both the White House and Congress. The possibility that lawmakers choose not to act is “remote,” said Luther.
“It's a messy way to engage in politics, but I don't think that there's too much to worry about from that in and of itself,” he said.
In 2011, financial markets plunged at the possibility that Congress might not raise the debt limit, which “put pressure on Congress to act,” said Mills.
“When there is no market reaction, it takes some of the pressure away,” he said. “The fact that Democrats do have a mechanism to raise it without any Republican support, it keeps people confident that something is going to happen.”
Still, absent any market reaction, the pressure from Wall Street and corporate America is vital to get something passed, said Campbell. The Business Roundtable, which counts JPMorgan Chase Chairman and CEO Jamie Dimon among its board of directors, has also sent a letter to congressional leadership about raising the debt limit.
“The pressure is important because it helps grease the wheels to get things like this done that are entirely and horribly politically charged and seen as very negative votes from both sides for different reasons, and so therefore, a very unpopular vote,” Campbell said.
Although some have theorized that financial institutions could tighten lending standards if the battle over the limit were to be drawn out due to uncertainty about the path of the economy, banks aren’t currently pricing in that possibility, said Mills.
“I'm not aware of a bank that really has the ability to kind of dial up or dial down all of their lending standards that quickly,” he said.
“Washington does not work unless there is a deadline,” Campbell said. “Washington has evolved to a place now where it is a lot like most high-schoolers, where they love to procrastinate, but are fantastic at getting and turning their work in right at the eleventh hour.”
