TOPICS > Politics

How Does the U.S. Debt Ceiling Work and Why Does it Matter?

May 16, 2011 at 12:00 AM EST
The United States government hit the legal limit for the amount of money it can borrow Monday, but Treasury officials say they can take other measures to pay the bills. Ray Suarez discusses questions about how the debt ceiling works and the ongoing political debate with The New York Times' Binyamin Applebaum.
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RAY SUAREZ: Next, The United States government hit the end of its credit line today, the legal limit for the amount of money it can borrow.

For now, Treasury officials say they can take other measures to pay the bills, but the ongoing political debate and reaching that milestone raises questions about how the debt ceiling works and what the federal government will do now when it needs cash.

To help us explain all of this, we’re joined by Binyamin Appelbaum of The New York Times.

And, Binyamin, I guess the most basic way to start, whether you call it a ceiling, a cap, or a limit, dinnertime Monday, May 16, can the federal government borrow money to meet its daily obligations?

BINYAMIN APPELBAUM, The New York Times: It is out of borrowing room. It’s as if it has hit the limit on its credit card. Yours might be $5,000. Theirs is $14 trillion. But we’re done.

So going forward, until Congress agrees to raise that limit, the government needs to pay its bills in other ways.

RAY SUAREZ: Day after day after day, the government spends more than it collects in revenues. So how come a default doesn’t happen right after the ceiling is hit?

BINYAMIN APPELBAUM: So we spend about $120 billion more each month than we take in, in revenues. That’s the amount Treasury needs to find somewhere.

The government has a bank account at the Federal Reserve with a little bit more than $100 billion in it. It’s going to use that money. There are a number of places that we borrow from that we don’t do to pay our bills; we do really as a favor.

We borrow from local governments. We borrow from the pension plan that serves federal workers. And the government is going to stop doing those things, and instead borrow for its general needs. That — that conserves some room as well.

All of these measures last until early August. That’s when the government runs out of money, even under those extraordinary measures.

RAY SUAREZ: Is that an estimate, or is that hard and fast data?

BINYAMIN APPELBAUM: It’s an estimate.

RAY SUAREZ: It’s an estimate.

BINYAMIN APPELBAUM: That’s the best guess that the Treasury Department has of when they will hit that final cap. But it could move a couple weeks either way.

RAY SUAREZ: Could the cap be used as a way of simply limiting federal spending, the way I guess some people would like to see it done; Uncle Sam basically says, well, we don’t have any more money, so we just won’t spend any more money?

BINYAMIN APPELBAUM: There certainly are people who would like to try that experiment. There are a lot of very reasonable economists who think it would be roughly the equivalent of chopping off someone’s arms and legs because they don’t fit in a bed. It would be dramatic, it would be extreme, and it would require massive cuts fairly instantaneously.

RAY SUAREZ: All right, turning that around then, what are the risks involved in not raising the debt limit?

BINYAMIN APPELBAUM: You know, what’s interesting about this is, really, the risks are the same either way. It’s a question of how soon they arrive.

If we keep raising the debt limit and keep borrowing more and more money, eventually, markets will lose confidence in the ability of the federal government to repay those debts and the cost of borrowing starts to increase.

If we refuse to raise the debt limit, investors may lose confidence much more quickly, and borrowing costs start to increase. But neither extreme works really well for us in the long run.

RAY SUAREZ: There are, so, roughly 11 weeks until the new August deadline. Given how much more money the government needs to operate than it collects, is there a danger involved, a danger to the cost of borrowing money that gets greater as you get closer to that deadline?

BINYAMIN APPELBAUM: There is. It’s as if we’re walking toward a cliff, and we don’t know quite where it is. At some point, markets could begin to fear that this won’t be resolved or won’t be resolved in a timely fashion.

If and when that happens, the government starts to pay more money to borrow. And that gets very expensive for taxpayers very quickly. Even a tiny, incremental increase in the amount that the government needs to pay to borrow money could cost hundreds of millions of dollars to taxpayers.

And we have seen in past debt crises, in past instances when we have approached this limit, that markets have sometimes responded by starting to charge a larger risk premium in order to lend money to the federal government.

If that happens now, life becomes more expensive starting whenever that happens.

RAY SUAREZ: So, that nervousness, that insecurity means that people are not willing to lend on favorable terms.

BINYAMIN APPELBAUM: Right now, the government borrows more cheaply than anyone else in the world. Nothing is as sure in financial markets than that the United States government will repay its debts. And so the government gets the cheapest rates available.

If people start to doubt that, if lenders start to doubt that the government can repay its debts or will repay its debts, those rates will start to rise.

RAY SUAREZ: We have been up against this threshold more than 70 times before. How come this time feels different from some of those other ones that were just settled with a pro forma vote?

BINYAMIN APPELBAUM: You know I’m not sure how different this time is.

We have certainly been through this process before of seeing one party in Congress and the other party in the White House sort of warring over the terms of an increase in the debt ceiling. We saw it in the Reagan administration, the Bush administration, the Clinton administration.

What sets this apart a little bit is that the size of the debt keeps getting bigger and bigger and bigger. And so the consequences of playing this game become larger and the wiggle room gets smaller, because all of these emergency measures that we’re now taking, which used to buy months and months of additional time, now buy, as you said, just a couple months.

RAY SUAREZ: On one side of the argument, people from the administration are promising calamity if Aug. 2 comes and goes with no settlement for this, while some on the other side are saying, well it’s a detail. It’s — we will miss a couple of payments for a couple of days or a couple of weeks, but then, eventually, this will get settled.

Is the truth somewhere in the middle?

BINYAMIN APPELBAUM: We don’t know.

You know, I think Robert Rubin, the former treasury secretary, said it best. He said, we don’t know what will happen, but why would you want to find out? And that seems to be, you know, a perspective that certainly all of our former treasury secretaries have, that you’re wandering off into an unknown space. There is no telling how markets would respond if the government stops paying some of its bills.

Some people are willing to run that experiment. Others fear it greatly and don’t want to. But we really won’t know until, if and when we get there.

RAY SUAREZ: And quickly, before we go, what’s the latest reports from the battlefront? Are the two sides, under the guidance of Joe Biden, reporting much progress in crafting a deal that will both cut expenditures and raise the debt ceiling?

BINYAMIN APPELBAUM: No. But that’s not surprising. This is Washington. If this happens, it will probably happen in early August.

RAY SUAREZ: Binyamin Appelbaum thanks for joining us.

BINYAMIN APPELBAUM: Thank you.