The U.S. Debt Ceiling: Shrinking Headroom

The U.S. government is moving closer to its $12.1 trillion debt ceiling. On Sept. 30, 2009, public debt subject to the limit totaled $11.9 trillion, leaving $250 billion headroom. Standard & Poor's Ratings Services expects Congress to increase the limit this quarter. However, the required legislation may become enmeshed in other current political debates, which will raise uncertainty in the government debt markets and may disrupt some government functioning.

Nonetheless, we do not believe that the debt-ceiling issue will prevent timely service of U.S. federal government debt. Our rating of U.S. government debt remains AAA with a stable outlook.

The U.S. is unusual among the 123 sovereign issuers that Standard & Poor's rates in that it sets a statutory limit for nominal debt outstanding and more particularly has its legislature vote on the limit most often apart from the approval of the budget. The bifurcated process can thus allow a lawmaker to vote for higher spending or lower taxes while later posturing against the government debt that is engendered by fiscal deficits. We consider that this process is not best practice and is a weak point in an otherwise strong budgetary framework.

The U.S. government has been operating under a fixed debt ceiling (as opposed to specific congressional authority for specific debt issues) since 1941. The limit applies to most debt the U.S. Treasury issues, regardless of whether it is held by the private or public sectors, and to federal agency debt that is explicitly guaranteed, namely debentures the Federal Housing Administration issues. Certain small categories of U.S. federal debt are excluded from the ceiling but they are not material in amounts outstanding.

Apart from the U.S. federal debt ceiling, some U.S. government agencies, such as the Federal Financing Bank or the Tennessee Valley Authority, have congressionally approved debt ceilings of their own.

Raising the Ceiling: A Regular Occurrence Congress has raised the U.S. federal debt ceiling 76 times since 1960, sometimes giving several years of headroom, sometimes not. Most of those times, Congress raised the debt ceiling before it was hit, but other times Congress reacted only after debt outstanding had reached its statutory limit.

In these instances, the U.S. Treasury must engage in some legerdemain to create additional headroom. One possibility is to withdraw government debt holdings of the Government Securities Investment Fund (G Fund), a defined contribution plan for federal employees. The government makes the withdrawal with the understanding that it will replenish the G Fund with interest when the debt ceiling is increased. On Dec. 31, 2008, $113 billion of government securities were in the G Fund.

Another potential source of headroom would be suspending payments to and redeeming government securities held by the Civil Service Retirement and Disability Fund. The amount of headroom that this approach can add varies with actuarial assumptions, but currently represents roughly $3 billion a month.

A third source of headroom could come from selling part of dollar holdings on the Exchange Stabilization Fund. On July 31, 2009, there was $16 billion available from this source.

A fourth source would be for the federal government to cease providing state and local governments with non-negotiable U.S. federal debt for escrow accounts.

A fifth source of headroom would be for the U.S. Treasury to sell its holdings of Fannie Mae (FNM) and Freddie Mac (FRE) debt, which totaled $165 billion as of Sept. 30, 2009. However, if the Treasury were to liquidate these fiscal assets, the sale could disrupt the very markets the original purchases had intended to calm.

Avoiding a Partial Shutdown With a projected 2010 deficit of $1.5 trillion and a 2010 projected change of gross federal debt of $1.9 trillion and with unexpected claims on government resources that can come from the financial sector, all of the five measures are stopgaps. Once the government has exhausted these additional means of obtaining headroom, an unadjusted debt ceiling could require large parts ("nonessential" parts) of the government to shut down, as it did twice for several days in late 1995.

We believe that the ensuing public discontent, should the government be forced to shut down partly, would soon prompt lawmakers to raise the debt ceiling.

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