U.S. hits debt ceiling

@CNNMoney May 17, 2011: 7:42 PM ET
The tap dance begins: Treasury Secretary Geithner said he can move money around to keep U.S. out of default until Aug. 2.

The tap dance begins: Treasury Secretary Geithner said he can move money around to keep U.S. out of default until Aug. 2.

NEW YORK (CNNMoney) -- It's official: The U.S. government hit the debt ceiling on May 16.

Treasury Secretary Tim Geithner told Congress he would have to suspend investments in federal retirement funds until Aug. 2 in order to create room for the government to continue borrowing in the debt markets.

The funds will be made whole once the debt limit is increased, Geithner said in a letter. "Federal retirees and employees will be unaffected by these actions."

He went on to urge Congress once again to raise the country's legal borrowing limit soon "to protect the full faith and credit of the United States and avoid catastrophic economic consequences for citizens."

Congress, meanwhile, is not showing any signs of budging. Many Republicans and some Democrats say they won't raise it unless Congress and President Obama agree to significant spending cuts and other ways to curb debt. (Social Security and Medicare squeezed)

Geithner told Congress that he estimates he has enough legal hoop-jumping tricks to cover them for another 11 weeks or so.

But then he said that's it. If lawmakers don't get it together by Aug. 2, the United States will no longer be able to pay its bills in full. (Slashing spending alone won't cut it)

The rhetoric about whether to raise the ceiling and under what conditions has been loud, harsh and, at times, misleading. Exasperatingly, it's far from over.

What is the debt ceiling exactly? It's 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 (i.e., anyone who buys U.S. bonds) plus debt owed to federal government trust funds such as those for Social Security and Medicare.

The first limit was set in 1917 and set at $11.5 billion, according to the Center for a Responsible Federal Budget. Previously, Congress had to sign off every time the federal government issued debt. (Take CNNMoney's deficit quiz)

How high is the debt limit right now? The ceiling is currently set at $14.294 trillion. The country's accrued debt hit that mark on the morning of May 16.

But by taking various extraordinary measures like suspending investments in federal retirement funds, Geithner will be able to bring total debt down enough to allow the government to continue borrowing until Aug. 2.

Hence, by the end of trade on May 16, total debt subject to the limit was a mere $25 million shy of the official cap -- or $14,293,975,000,000. Total debt can fluctuate up or down on any given day.

How is the ceiling determined? They don't admit it, but lawmakers tacitly agree to raise the debt ceiling every time they vote for a spending hike or tax cut.

"Congress has already passed and the president has already signed legislation that increases spending or decreases revenues. Those decisions have already been made," said Susan Irving, director for federal budget issues at the Government Accountability Office.

So in reality arguing over the debt ceiling is essentially arguing over whether to pay the bills the country has already incurred.

Debt ceiling: Time to get real

But politicians who make a stink about the debt ceiling will always try to make the case that the guy who votes to raise it is a fiscal spendthrift.

And politics, of course, permeates the whole debate. Lawmakers who want to make hay of the issue for political gain may push for a small increase so the debate comes up again soon. Others may want a bigger increase so they don't have to revisit the issue for awhile.

How many times has the ceiling been raised? Since March 1962, the debt ceiling has been raised 74 times, according to the Congressional Research Service. Ten of those times have occurred since 2001.

Expect more of the same over the next decade. Barring major changes to spending and tax policies, "Congress would repeatedly face demands to raise the debt limit," CRS wrote.

Why does Congress even bother to set a debt limit? In theory, the limit is supposed to help Congress control spending. In reality, it doesn't.

Every time the debt limit needs to be raised, lawmakers and the president are forced to take stock of the country's fiscal direction, which isn't a bad thing necessarily.

But the decision about how high to set the ceiling is divorced from lawmakers' decisions to pass spending hikes and tax cuts. It's also made after the fact, so it doesn't do much to pull in the purse strings.

That's why budget experts say it would be better to tie the debt limit decision to lawmakers' legislative actions.

What happens if Congress doesn't raise the debt ceiling before Aug. 2? No one knows for sure. But the going assumption is that no good can come of it.

What happens if Congress blows the debt ceiling?

Treasury would not have authority to borrow any more money. And that can be a problem since the government borrows to make up the difference between what it spends and what it takes in. It uses that borrowed money to help fund operations and pay creditors.

Geithner's critics say he could prevent default by simply paying the interest due to bondholders.

But since average spending -- minus interest -- outpaces revenue by about $118 billion a month, Geithner won't be able to pay all the country's bills.

That means he will have to pick and choose who to pay and who to put off every day. And there's no guarantee that paying interest while shirking other legal obligations will protect the country from the perception of default.

Geithner said it would be akin to a homeowner who pays his mortgage but puts off his car loan, credit cards, insurance premiums and utilities. The mortgage is taken care of, but the homeowner's credit could still be damaged.

Ultimately, if lawmakers fail to raise the ceiling this year, they will have two choices, both awful.

They could either cut spending or raise taxes by several hundred billion dollars just to get through Sept. 30, which is the end of the fiscal year. Or they could acknowledge that the country would be unable to pay what it owes in full and the United States could effectively default on some of its obligations.

The first option would be impossible to execute without serious economic repercussions.

And the second option could cripple the economy and send world markets into a tailspin.

"Not only the default but efforts to resolve it would arguably have negative repercussions on both domestic and international financial markets and economies," according to the CRS.

At a minimum, a default could hurt U.S. bonds, the dollar and investors' portfolios. "Our bond market and stock market would crash," said former Congressional Budget Director Rudolph Penner.

Will reaching the debt ceiling for good cause a government shutdown? Not technically.

A government shutdown occurs if lawmakers fail to appropriate money for federal agencies and programs.

By contrast, if the debt ceiling is breached, Uncle Sam would still have revenue coming in that could be used to fund the government, Penner noted.

But if Geithner is coming up short by $118 billion every month, and lawmakers just decide to cut spending by that amount, that could effectively mean a partial government shutdown. To top of page

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