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Debt ceiling: What is it and why it's important to Utah investors

Published October 14, 2013 9:49 pm

Economy • Most economists and financial advisers agree defaulting on loans would have an immediate and devastating impact.
This is an archived article that was published on sltrib.com in 2013, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

There's a scene in the classic comedy, "Animal House," that perfectly captures the current state of the country as it approaches the deadline to raise the federal debt ceiling. As a frenzied crowd runs around in a panic, Kevin Bacon's character shouts out, "Remain calm! All is well!" But the hysterical group instead runs over him, literally stomping him into the pavement.

Certainly there are frayed nerves as we approach Thursday's deadline to raise the limit of our nation's debt. Meanwhile, financial advisers are much like the Bacon character, trying to calm their clients' anxiety. Many insist that despite all of the political posturing, we will not default on our loans, and people should just weather out this brief storm.

But the United States has never defaulted on its loans before, and economists and advisers mostly agree on one thing: No one knows exactly what will happen after that, only that it will have a tremendous impact on the economy.

"I don't think anybody has been an expert on this," said Richard Evans, assistant professor of economics at Brigham Young University. "It would be unprecedented."

In much of history, the country has been in debt, owing both foreign countries like China as well as its own citizens through bonds. The debt limit has been raised many times, and the country's debt now stands at $16.7 trillion.

The last time the country came this close to defaulting on its loans was in the summer of 2011, and it resulted in the first downgrading of the country's credit rating. This time, the standoff is over the funding of Obamacare and the government shutdown. Republican members of Congress have been pushing the Democrats to delay its implementation or defund the Affordable Care Act and using the current government shutdown, and now the threat of not raising the debt ceiling, for leverage.

If the debt ceiling is not raised again by Thursday, the country will not have enough money to meet all of its financial obligations, and that could lead to disastrous results, according to economists. Meanwhile, Republican congressional leaders have been meeting with President Obama to hash out a deal. A proposal to extend the debt ceiling for another six weeks was rejected by the president Thursday, and the parties are going back to the drawing board to find a solution to the government shutdown and a more permanent raising of the debt limit.

To demonstrate how sensitive the situation is and its effect on the volatility of the stock market, news that the two parties were willing to meet Thursday to reach a solution resulted in the Dow Jones industrial average to skyrocket more than 320 points, the biggest single-day jump since January.

Brian Moynihan, chief executive of Bank of America, said earlier this month, "There's no debate that the seriousness of the U.S. not paying its debts … is the most serious thing we have, and we witnessed that in August '11 and you saw the ramifications ­— a slowdown in the economy."

Goldman Sachs CEO Lloyd Blankfein added that "We're the most important economy in the world. We're the reserve currency of the world. Payments have to go out to people. If money doesn't flow in, then money doesn't flow out. So we really haven't seen this before, and I'm not anxious to be a part of the process that witnesses it."

While no one knows the exact consequences of the country not paying back its debt, most agree it could put the economy in a rapid tailspin.

"Interest rates will soar, stock prices will plummet, the global economy will begin spiraling downward, and millions of Americans wouldn't receive their Social Security and Medicare," economist and former U.S. labor secretary, Robert Reich, wrote in The Huffington Post.

BYU's Evans thinks differently. He believes it won't be cataclysmic because the U.S. has enough incoming money to at least pay its most immediate debts.

"Even if they did default, it wouldn't be catastrophic. You still have to help the economy," he said. "This is a political hiccup. I don't see a scenario in which the country is going to fall into the ocean from this."

Either way, the government will not let it get that far, said Matt Johnson, managing director and wealth adviser with Zions Bank.

"The consequences of not making good on our interest payments are very, very significant, and I think both parties know that," he said. "We have been close to this thing in the past, and everybody realizes that the short-term and long-term consequences on the markets would be would large enough that we would have to come to a compromise."

In the meantime, Johnson recommends that consumers consider paying off their credit card debt and try to go to fixed interest rates on other big loans such as mortgages. Rising interest rates could be an immediate effect should the country default on its loans, and that will result in higher monthly payments on your loans with variable rates.

If you have a stock portfolio or retirement plan, he also recommends people contact their financial or retirement advisers to talk about whether their portfolios need adjusting. That can vary depending on how close you are to retirement. But people should figure out how much of their investments go into what he calls the "risk" bucket and how much goes into the "capital preservation," or "safe," bucket.

"The right way to approach this is to say, 'This is a volatile time. We will have major swings in all risk assets.' Make sure you have the right amount in the risk bucket so you don't panic," he said. "Sizing those two buckets — that is the key to success."

vince@sltrib.com

Twitter: @ohmytech