Lawmakers announced Thursday that they'd reached a deal to raise the debt ceiling — for now, anyway.
"I have some good news," Senate Majority Leader Chuck Schumer announced on the Senate floor. "We have reached an agreement to extend the debt ceiling through early December, and it's our hope that we can get this done as soon as today." The Senate approved the deal on Thursday evening, passing the legislation to the House, which is expected to take it up early next week.
The deal averts, at least temporarily, what many experts said could be a crisis scenario. A failure to raise the ceiling by October 18 could have triggered a default on U.S.-issued debt, which Treasury Secretary Janet Yellen recently wrote in a Wall Street Journal op-ed would "likely precipitate a historic financial crisis."
Investors were worried. The impending debt ceiling deadline, along with other risks facing the stock market, saw stock prices trading on shaky ground to begin October. Market-watchers can now scratch a U.S. default off of their list of worries, at least until December 3 — the new date for when the U.S. will no longer be able to pay its bills.
Video by Stephen Parkhurst
Here's what you need to know about the debt ceiling, and why investors will be keeping an eye on it for the coming months.
As you may have heard, the U.S. government is in debt. It owes money to cover its obligations, such as Social Security and Medicare payments, military salaries, and tax refunds. The debt ceiling is the maximum amount of money that the government can raise via bond sales to meet those obligations.
"Because the government runs budget deficits, debt accumulates every year," says Jason Herried, director of equity strategy at Johnson Financial Group. "The debt ceiling is a cap on what the government can spend. It's just like a credit card — once you hit the limit, you're maxed out and can't borrow any more."
The agreement reached in Congress Thursday expanded that limit by $480 billion, the amount the Treasury Department estimates will allow it to pay the government's bills until the new deadline. If the Congress fails to come up with a new deal by then, the government would at least temporarily be unable to meet its obligations.
"Nearly 50 million seniors could stop receiving Social Security checks for a time. Troops could go unpaid. Millions of families who rely on the monthly Child Tax Credit could see delays," Yellen wrote in her op-ed. "In a matter of days, millions of Americans could be strapped for cash."
The U.S. government has never defaulted on its debt, but that's what would happen should Congress fail to reach a new deal to raise the ceiling before December 3. The nearer the deadline draws without another deal, the more nervous investors could become.
That's because a default on bonds issued by the Treasury is a big deal, says Brad McMillan, CIO of the Commonwealth Financial Network. "Treasury obligations are debt that investors have always assumed to be risk-free," he says. "Because of that, the interest rate on Treasurys is the foundation for all other asset valuations. A default, in theory, could be an earthquake for those assets."
Video by Helen Zhao
A default would also likely come with a downgrade of the U.S. government's credit rating from the highest rating of triple-A — something that credit rating agencies indicated was very possible in advance of the October deadline. A downgrade would crater the value of Treasurys and could spike borrowing costs on car loans, credit cards, and mortgages, all of which come with rates that are pegged to U.S. Treasury rates, since bond prices and yields move in opposite directions.
In 2011, political squabbling in Congress kept debt ceiling legislation from getting passed until just two days before the August 2 deadline. That ordeal also included a credit downgrade from Standard & Poor's. Investors responded to the uncertainty by pushing the S&P 500 down more than 18% between July and October of that year.
Video by David Fang
Because of its potential for calamity if left unaddressed, the debt ceiling will stay on investors' radar screens until a new deal is passed, but they can be confident that some kind of resolution will be reached, says Herried. "Ultimately, politicians need to get reelected," he says. "If you're running against someone who did something to significantly upset the economy or markets, you have a very good case to make that you should replace them."
And even if lawmakers drag their feet and let the prospect of a default roil markets, investors would be wise to view any drawdown as short-term turbulence, says Kristina Hooper, chief global market strategist at Invesco. "Let's take a step back and ask ourselves, 'Is this going to have a long-term impact?' Probably not," she says. "Could it cause a big sell-off? Absolutely. But that's likely going to be short term in nature."
If it comes to that, Hooper says, you would probably be better served in the long run by steadily adding to your portfolio rather than panicking and selling your investments. "You should be dollar-cost averaging through dips," she says. "Any time there's a sell-off, it's a good time to add cash sitting on the sidelines."
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