Photo (cc) by paul bica
This is a guest post from partner site LowCards.com
(Editor’s note: We’ve been writing extensively about the debt ceiling in articles from Follow the Debt Ceiling Debate to 5 Funny Debt Ceiling Videos. Following is a post from another site for an additional point of view.)
Congress and President Obama have not reached a compromise on the debt ceiling, so the political drama continues. If the politicians can’t reach an agreement on the debt ceiling and budget issues, the nation could enter another “deep economic crisis” that would affect all Americans.
Consequences could range from higher interest rates for all consumer loans, job furloughs, and closed national parks to another blow to a fragile economy. The numbers are large and the problems are complicated, but the issue is important for all Americans to understand.
What is the debt ceiling?
The government borrows money to make up the difference between what it pays and what it takes in, and the debt ceiling is a cap set by Congress on the amount of debt the federal government can legally borrow. The cap applies to debt owed to the public (anyone who buys U.S. bonds) plus debt owed to federal government trust funds such as those for Social Security and Medicare. It is also money the country has already borrowed by issuing bonds and Treasury bills to pay for programs we have funded in the past.
The debt ceiling is currently set at $14.3 trillion and the government hit this cap on May 16, but the Treasury made adjustments to have enough room to borrow through Aug. 2. The debt ceiling is not a new issue, and raising the debt ceiling has actually become a common practice by Congress. In fact, the debt ceiling has been raised 74 times since March 1962, according to the Congressional Research Service (source: CNN).
This time is different because there is not enough support for proposed plans from the president or either party. A number of politicians were elected to office on the pledge to reduce spending and limit taxes, and their mission is to force the nation to live within its means, no matter the cost.
Consequences of a lower credit rating
If Congress can’t reach a satisfactory deal that either raises the ceiling or cuts spending, credit agencies warn that they will downgrade the United States’ credit rating from the top “AAA” rating that this country has always enjoyed. The AAA rating means the U.S. has the lowest lending risk and therefore receives the lowest interest rates. The government now pays $250 billion a year in interest on its debt.
The effects of a downgraded credit rating for the government are similar to a lower personal credit score. It indicates that the government is at a higher risk for default, and lenders will subsequently demand a higher rate of return with higher interest rates.
If the government has a lower credit score, every American will pay a higher price. Interest rates will increase for all consumer loans, including college loans, auto loans, mortgages, and credit cards. This will be another tough blow that reduces income for households still trying to recover from the financial crisis of 2008.
“Interest rates would skyrocket on credit cards, on mortgages, and on car loans,” said President Obama on Monday.
“Interest rate increases are always bad news for households, especially those who use loans to make ends meet,” says Bill Hardekopf, CEO of LowCards.com and author of The Credit Card Guidebook. “Higher interest rates add to the cost of the loan and suck away money that should be used to pay off debt, to spend, or to save. Higher interest rates reduce household income and will put many families even further at risk.”
Credit cards are the easiest form of credit, but the average interest rate is already very expensive. The average advertised credit card APR is currently 14.08 percent, up from 11.64 percent in May 2009, the week the CARD Act passed (LowCards.com Complete Credit Card Index).
“Nearly every credit card on the market today is a variable-rate card. Most of those are tied to the prime rate, so if the prime rate were to increase, then the interest rates on those credit cards will undergo a corresponding increase,” says Hardekopf. “And unlike other interest-rate hikes where issuers now have to give you a 45-day notice, when your APR increases due to a hike in the prime rate, that increase can take place immediately. But any interest rate increase will only apply to your future purchases, not your existing balance.”
Losing the top rating could also increase borrowing for state and local governments and could mean less money to spend on education, national parks, health care, roads, and services. It could open the door to tax hikes.
A downgrade is different than default and has less severe consequences. A default occurs when the government fails to pay its creditors, just like cardholders who can’t pay their credit card bills.