Q: Are we heading toward another financial crisis? Gridlock in Washington and the potential debt ceiling fight has me very nervous.
A: Let’s review the debt ceiling issue first. The Treasury has said that it will exhaust cash balances by June. Other estimates, such as from Goldman Sachs, project a slightly later date of August. At that point, paying the government’s bills will not be possible without deficit financing and will require a debt limit increase. Congressional leaders have said they will not allow the government to default. They bear significant political risk for failing to make a deal, but that deal could take time to work out, as both sides express a hard line in terms of expectations.
In a drawn-out debate, we should expect more volatility and short-term pressure in a bond market heavily dominated by US treasuries. Short term rates could increase (as in 1979) or a downgrade in the credit rating of government bonds could occur (as in 2011).
Neither previous debt ceiling breaches resulted in financial crisis. There is too much incentive for lawmakers to iron out a deal for this to get so dire. But the road to a compromise will be rocky, though not so much that long-term investors should abandon good process.
