Debt Ceiling: Lessons from the 2011 Budget Debate

The House of Representatives and the White House appear to be locking horns over the Federal budget and on raising the debt limit that could potentially delay coupon and principal payments on U.S. Treasury issued Bills, Notes and Bonds. The Congressional Budget Office suggested in mid-February that the government could run out of cash between July and September. The amount of tax revenues received in April could bring the date forward or push it back within the three-month range. Regardless, Q3 2023 could be fraught with challenges for investors in U.S. government securities as well as in equities, gold and other assets.

So, if the budget debate in Washington comes down to the wire, what should investors expect? While there have been several government shutdowns over the past few decades including in 1995-96, 2013, and 2018-19, only during the summer of 2011 did the possibility of default come to the fore. Looking back at the summer of 2011 can be instructive for investors in terms of how different markets reacted at the time. However, it’s important to note that economic and financial conditions in 2011 were very different than they are today. As such, even if the current budget debate were to take a similar course to that of 2011, there is no guarantee that investors’ response would be similar.

Before we get to 2011, it is important to note the difference between a a government funding crisis and a debt ceiling breach. A funding crisis creates a partial shutdown of non-essential government services – with the potential for about 800,000 employees to be furloughed. When the funding deal is finally approved, workers get back-pay. The debt ceiling issue is different. Tax revenues will make up approximately 80% of what the Federal government needs to meet its expenses. However, the U.S. Congress has never provided the executive branch with legislative direction as to who to pay first.

Individuals, when faced with a shortage of cash and credit lines, typically pay their mortgage and car loan first. If something must be skipped, it will be student loans and credit card payments. The government, though, has no priority list. Do they pay military and veterans and not pay Social Security, Medicare and Medicaid, or do they prioritize paying investors with maturing T-Bills/Bonds or the coupons on Treasuries? The absence of prioritization leaves open the possibility that nobody will get paid. As such, a debt default isn’t only about bond investors which makes a potential debt default potentially much more impactful for consumer spending, business investment and overall economic activity than a government shutdown.