How the U.S. Debt Ceiling May Affect You

A debt ceiling “crisis” is nothing new. Historically, Congress has always suspended or raised the debt limit to ensure the U.S. avoided default. But as happens frequently with a divided government, lawmakers are currently at an impasse. Republicans in the House passed a bill that would raise the debt limit in exchange for spending cuts. Democrats, on the other hand, are looking for a bill that would raise the debt ceiling without any spending cuts or other conditions. It's clear that a deal will need to be reached with both sides making concessions.

There are two ways to look at bond values. First, there is the value of the bond when it matures. If you have a $10,000 bond that matures in 20 years, you'll receive interest on that bond over the next 20 years, and then you'll receive your $10,000 back at the end of that 20 year term.

The second way to look at bond values is the value a bond trades at on the open market prior to its maturity. If that 20-year $10,000 bond you own is paying interest at 3% per year, and interest rates for new bonds are 3%, then you might get $10,000 if you wanted to sell the bond now. However, if new bonds are paying 5% per year, no one will want to buy your bond for $10,000 if they can buy a new one with a better interest rate. That means you need to sell your bond for less than $10,000 to make up for the difference in the interest rate. Likewise, if your bond is paying that 3% interest rate, but new bonds have an interest rate of only 1%, you could probably sell your bond on the open market for more than $10,000.

So, when you read or hear about bonds losing value, what you're really hearing about is the value the bonds have on the open market. Investors who want to sell bonds on the open market may be losing money on their bonds because interest rates have risen so much and they now own older bonds with lower interest rates. However, if there is no need for the money that was invested in those bonds right now, they could be held until maturity and then redeemed for the original investment amount (called par), with the investor receiving their original $10,000 back.

Bonds only lose value in these situations if you want or need to sell them before maturity, or if they become completely unredeemable (i.e. a corporation or government bankruptcy prevents redemption).

If the U.S. government defaults on its debt as a result of not raising the debt ceiling, then what could happen is that the bonds that mature during the period the government is shut down may lose value. Investors may not be able to redeem the bonds, and if they need the money right away, they may be forced to sell them for less than the par value. However, even if there is a government shutdown and potential default on the government's debt, once the matter is cleared up (i.e. the debt ceiling is raised) and the government is able to resume redemptions of its bonds, then investors would be able to redeem their bonds at full par value, even the ones that matured during the shutdown and redemption freeze.

So, no, your bonds won't become worthless just because the debt ceiling isn't raised. However, if you really need the money from redeeming a bond during a potential shutdown and redemption freeze, you could lose some money if you need to sell your bonds on the open market.

Money market funds are typically mutual funds with shares that are pegged to the U.S. dollar, meaning each share is worth $1.00. This is because they typically invest in cash, cash equivalents, and short-term government Treasuries (i.e. Treasury bills). If there is a default on U.S. government debt, it may make it difficult or impossible for money market funds to redeem their short-term Treasuries to fulfill potential redemptions or withdrawals from money market funds and accounts. In such a scenario really anything could happen, but two likely results come to mind.

• A money market fund could pause redemptions until the debt ceiling issue is resolved and they are able to redeem short-term Treasuries. If that were to occur, investors would not be able to sell their money market shares (redeem with the fund) to withdraw cash.
• The money market fund could lose its peg to the U.S. dollar. It could be possible that, instead of receiving $1.00 for each share, investors would receive $0.99 or $0.98, or even a lower amount, for each share if they wanted to redeem them during this period of time. Once the debt ceiling were raised and redemption of U.S. Treasuries resumes, then the value of each share would likely return to $1.00.

It's unclear what exactly would happen, and what happens to each money market fund (there are hundreds) could be different.

If you currently own U.S. Treasury debt (bills, bonds, etc.) and you think you'll have to redeem or sell them in the near future because of a cash need, you may want to consider doing that now. If the branches of government cannot make a deal, resulting in a government shutdown and potential freeze of U.S. Treasury redemptions, it's not clear how long that could last. It could be days or weeks. More recent shutdowns over the past 30 years have been about two to three weeks.

If you currently own money market funds and you think you'll need to redeem any or all of your money market holdings in the near future, you may want to consider redeeming your shares now, before any kind of shutdown occurs. If a deal is reached, or after any potential shutdown is over, you'll be able to buy into that mutual fund again afterwards.

If you currently receive Social Security benefits it is a good idea to review your budget to find any areas that you may be able to reduce you expenses if you think it will be difficult to cover the costs until Social Security payments are resumed. Keep in mind, that payments would simply be paused and you would receive back payments that were missed once Social Security resumes.

The bottom line that everyone should realize or remember, is that we've been here before. The branches of government have disagreed on budget and debt ceiling issues before, and there have been government shutdowns in the past. In the end, agreements were made eventually, and everything turned out fine. There's no reason to think otherwise this time around, and thus no reason to worry.

 As your financial professional team, we’re here to help handle whatever is thrown at you and keep you focused on your financial goals.

Even if any of the above worst-case scenarios were to become a reality, implementing any of the above suggestions may not be necessary at all. There's a possibility that you have other sources of income to meet your current and near future financial needs.

A qualified financial planner can help you determine the best course of action to meet your financial needs during times like this, and that's one of the reasons Escient Financial is here. Escient Financial is also here to help you reach your long-term goals, so it's equally important to keep those in mind when there are significant events in the economy such as this. It's always a good idea to regularly revisit your financial plan, conduct a full review, update and necessary, and implement any changes to make sure you stay on path to achieving your goals. If you want to make sure you're still on track to achieving your goals, whether they're short-term or long-term, feel free to...