Editor’s Note: This story originally appeared on NewRetirement.
“The ceiling is falling! The ceiling is falling!”
It is hard to know if the news of the debt ceiling is akin to Chicken Little’s misunderstanding or an actual looming crisis.
(In the story of Chicken Little, an acorn hits her head and she mistakes it as a sign that the sky is falling, leading her to spread hysteria throughout the countryside.)
Let’s explore what is going on with the debt ceiling – catastrophe or unwarranted panic – and how to prepare for what may come.
What Is a Debt Ceiling? Who Sets the Limits?
The debt ceiling is the limit on the amount of money that the federal government is authorized to borrow by issuing U.S. Treasury securities like savings bonds to meet its existing financial obligations.
Congress authorizes the borrowing by setting a limit on how much the government can borrow.
What Is a Debt Ceiling Crisis?
When people talk of the debt ceiling crisis they are referring to a scenario where the U.S. government is unable to make the required payments to their creditors, bond holders for programs already approved by Congress, without raising the debt ceiling.
The crisis is that the government cannot make payments on the debts if it doesn’t.
Because U.S. financial system is not just the “gold standard,” but THE standard for practically all financial assets in the world, default on these debts is hard to imagine. The ramifications are unsettling.
Treasury debt has always been thought of as “risk-free.”
NOTE: According to the New York Times, in all previous debt ceiling crises, the world’s investors have paradoxically actually put more money into Treasury securities, believing that it is still a safer place to put money than other options in a crisis.
How Can the Debt Ceiling Crisis Be Avoided?
Historically, Congress has always simply raised the debt ceiling which eliminated the crisis and any threat of financial meltdown.
According to the Department of the Treasury, “Congress has always acted when called upon to raise the debt limit. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. Congressional leaders in both parties have recognized that this is necessary.”
However, the fear this year is that the gulf in Congress between those who are willing to raise the debt limit and those who want to make cuts to future government spending before they are willing to raise the limit is wider than it ever has been before.
So, this story may be less about “chicken little” and more a game of chicken. Who is willing to compromise first and to what degree in order to avoid a debt ceiling crisis?
Changes to Social Security and Medicare and finding ways to make those programs solvent are likely to be on the negotiating table. (Learn more about the shortfalls facing Social Security and Medicare.)
Will the Debt Ceiling Actually Be Breached?
Well, yes.
We technically hit the limit on Jan. 19. However, the Treasury Department can use creative accounting to be able to continue paying the government’s bills. Experts warn that these maneuvers will be exhausted by June.
The date of actual default is being called “the X date.”
What Will Happen on the X Date: an Actual Debt Ceiling Crisis?
We don’t really know. It has never happened before.
What Should You Do to Protect Your Finances from a Debt Limit Breach?
A debt ceiling crisis isn’t so different from any other threat to your assets.
Experts recommend the tried and true strategies for major fluctuations in the financial markets.
1. Don’t Panic
If you have a long-term investment strategy in place and adequate cash on hand, you probably don’t need to worry.
We’ve weathered downturns before and have been muddling through some pretty big financial shocks over the last few years. And, there is no reason to believe that this possible crisis will be any different.
2. Prepare Mentally for Investment Declines
The emotional impact of losses, even losses that you know are short-term, can be difficult.
Prepare yourself mentally, have backup plans in place, and keep your eye on your long-term financial health. Understanding your emotions and keeping your eye on the big picture can mitigate bad decision making in a crisis.
3. Bolster Your Cash Emergency Funds
Experts recommend that everyone has adequate cash on hand to fund their expenses for anywhere between three months to five years. Your specific time horizon depends on the reliability of your income sources.
Not sure how much cash you need on hand?
Run scenarios in the NewRetirement Planner to help you establish baseline spending and savings needs and how to cope through crises.
4. Have a Long-Term Investment Strategy
The crisis may or may not happen. However, the machinations of business will march forward.
If you believe that there is value in the businesses in your investment portfolio and that people and businesses will continue to build additional value, then stick to your long-term investment strategy.
The debt ceiling crisis will probably just be another blip.
The financial markets have always recovered and exceeded previous crises.
5. If You Are a Government Employee, Social Security Recipient, and/or Medicare Beneficiary You May Want to Plan for a Pause in Payments
It is not clear who will get paid if we crash through the “X date” without raising the debt ceiling.
So, if you receive income or benefits from the federal government, you may want to consider and plan for how to cope if those payments are not made.
If you are worried, you may want to run a scenario in a retirement planner where you pause your government check for a specified period of time and address ways to bridge to restored compensation.
6. Be Prepared for Increases in Borrowing Costs
The debt ceiling crisis may cause interest rates for Treasurys to rise which would then increase interest rates across the rest of the economy.
The costs of borrowing – credit cards, car loans, mortgages, business investments, etc. – will rise.
If you have variable interest rates on debt, now may be a good time to lock in fixed rates.
7. Haven’t Yet Started Social Security or Medicare? Consider How a Future Reduction in Benefits Might Impact Your Projections
There is talk that members of Congress will use the debt ceiling crisis to force a reckoning for the solvency of Social Security and Medicare.
Ideas that have been considered include: raising the age for eligibility, changing the way cost-of-living adjustments (COLAs) are made, making benefits means tested through the middle class, and more.
If you have already started benefits, it is unlikely that anything will change for you. If you have not already started benefits, you may want to consider a possible reduction.
8. Contact Your Congressional Representatives
Have concerns? Contact your congressional representatives. Voting is not the only way to make your voice heard.
Find contact information for your elected official in the House of Representatives and Senate.