An upcoming vote in Congress to either raise or suspend the federal borrowing limit is becoming the latest political minefield for Democratic leaders, as they work overtime to hammer out massive spending and infrastructure bills in the coming weeks.
A two-year suspension of the debt ceiling that was passed in 2019 is set to expire at the end of this month, and Democrats do not appear to have a strategy in place yet to raise the limit to new heights or suspend it again.
“We’re considering all options,” House Speaker Nancy Pelosi, D-Calif., recently told Bloomberg News when asked about the Democrats’ strategy.
Republicans, meanwhile, appear poised to revive the debt ceiling wars they waged during the Obama administration after four years of relative silence about the debt limit hikes passed under GOP President Donald Trump.
If a deal on the debt limit hike falls prey to gamesmanship and procrastination, the consequences could be dire.
Failure to renew the current two-year suspension of the limit, or pass a new, higher limit before the congressional recess in August could pose a risk to the fragile economic recovery and result in serious repercussions for workers and businesses alike.
While the United States has never defaulted on its debt, recent history shows that getting uncomfortably close to it can create chaos. In 2011, House Republicans’ refusal to pass a debt ceiling increase led to a downgrade of the U.S. sovereign credit rating that upset financial markets.
Still, the political calculus in Congress over debt ceiling hikes is exceedingly difficult, with members in both parties reluctant to cast votes that could be seen as contributing to the massive national debt.
“Everybody knows that it has to be increased, except for the most demagogic of officials,” said Fundstrat Global Advisors policy strategist Tom Block. Still, “it’s one of the most politically fraught votes many members take.”
For lawmakers, the vote is often a delicate balance between appearing fiscally responsible in the next election and avoiding universally acknowledged economic upheaval.
For Pelosi the risk is the 2022 general elections.
She must not only drum up enough votes to pass a debt ceiling suspension, but also protect her razor-thin majority as House Democrats in swing districts will likely face intense challenges. The president’s party typically loses House seats in the midterms.
For Republicans, the risk is the 2022 primaries. While the GOP will be quick to hammer Democrats’ spending in the general election, each Republican who votes to suspend the ceiling opens themselves up to an attack from their right by an even more fiscally conservative rival.
In 2019, Congress voted to suspend the debt ceiling through July 2021. Debt limit suspension votes are typically more palatable to members of Congress than votes that raise the limit to new heights, because suspension votes don’t have a number attached to them.
But that 2019 suspension is expiring at the end of this month, and after that, barring a new vote, the Treasury Department won’t be able to raise additional cash by selling bonds.
Unless the debt ceiling is raised, the Treasury will need to start drawing on emergency accounts to pay the government’s tab.
And with an unprecedented spending thanks to Covid-19 stimulus, Treasury Secretary Janet Yellen has warned that she may not be able to sustain that emergency lifeblood for very long before reaching the all-important “drop-dead” date, when the government would trigger a technical default.
Known unknowns
The timing of that drop-dead date, however, is a matter of guesswork since economists don’t have precise measures of how much cash the Treasury has on hand and how much it’s doling out each day to pay the nation’s bills.
While the U.S. has never defaulted before, economists see that outcome as a doomsday scenario and a significant threat to several sectors of the American economy.
“The U.S. going back to George Washington has never defaulted on its debt. So that would set a pretty dangerous precedent,” said Michael Feroli, chief U.S. economist at JPMorgan.
In an extreme situation in which lawmakers can’t reach an agreement after the drop-dead date, lenders across the globe could demand higher interest payments from Uncle Sam.
That could spark a domino effect forcing interest rates throughout the U.S. economy — on everything from mortgages and auto loans to rates on corporate debt — to jump in sympathy.
Yellen and her staff haven’t been quiet about stressing the urgency of the 2021 vote as pandemic-era spending winds down. She warned senators in June that, given the historic spending, the Treasury could exhaust its emergency funds far sooner than in years past.
“It’s possible that we could reach that point while Congress is out in August,” she said, referring to lawmakers’ annual summer recess. “I think defaulting on the national debt should be regarded as unthinkable.”
“I believe it would precipitate a financial crisis: It would threaten the jobs and savings of Americans at a time when we’re still recovering from the Covid pandemic,” she added. “I would plead with Congress simply to protect the full faith and credit of the United States by acting to raise or suspend the debt limit as soon as possible.”
The mere specter of government default can have a material impact on markets.
In 2011, gridlocked House Republicans and the Obama White House came within days of a drop-dead default.
The S&P 500 fell for five days in a row leading up to the weekend that lawmakers finally struck a deal. That sell-off erased 4% from the market index and represented its worst week in more than 12 months.
The credit rating agency Standard & Poor’s downgraded U.S. credit for the first time in the country’s history from AAA to AA+.
A default “could create all sorts of chaos in financial markets,” Feroli said. “Some of that chaos is knowable, but it’s the unknowns that worry people a lot about the technical default.”
The JPMorgan economist added that business contracts often require parties to post collateral of nondefaulting entities, which to date has included Treasury bonds.
“If Treasury collateral is no longer eligible, then that would really pull the rug out from underneath the financial system,” he said.
Perennial political peril
Feroli and others are not worried about Washington’s ability to pay what it owes, however.
The real risk is that political aspirations for the 2022 election cycle prevent Yellen from paying the government’s bills on time.
And that’s because very few politicians, Democrat or Republican, enjoy being cast as endorsing an ever-ballooning federal debt, even if the government’s spending is otherwise popular.
Republicans, for example, have historically lobbied for billions of dollars for the military and the agricultural industries they represent. Democrats, meanwhile, currently seek trillions to support families, expand paid family leave programs and make college more affordable.
Complicating matters this year is the fact that members of Congress in both parties are eager to find compromise on a trillion-dollar infrastructure deal, and Democrats are trying to balance several competing interests within their caucus.
A successful infrastructure deal would mean that lawmakers could go home for recess later this year and show their constituents how much federal funding they’ve secured for the district’s roads, bridges and broadband.
The debt ceiling, on the other hand, is the opposite: A vote with no tangible benefit to show constituents, but plenty of downside when their opponents next year accuse them of ballooning the national debt.
Three options
In the coming weeks, House Speaker Pelosi will be faced with three options, each of which carries risks.
The first option would be to tuck a debt ceiling hike into the massive reconciliation bill Democrats plan to pass later this year.
The benefit of this strategy would be that the rest of the bill’s contents would likely distract voters from the unpopular debt ceiling vote buried in the thousands of pages of legislation.
The risk, however, is that negotiations over this Democrats-only bill are expected to stretch well into September, and possibly even October.
Given Yellen’s stark warnings about the Treasury’s limited ability to tap the government emergency funding, tying the debt ceiling to the reconciliation bill could amount to playing roulette with America’s credit rating.
The second option would be to set up a stand-alone vote to either suspend or raise the debt ceiling.
The benefit of this strategy would be that it avoids tying the borrowing limit to a tricky reconciliation bill.
But stand-alone votes to raise the debt ceiling are deeply unpopular with rank-and-file members, and Pelosi would likely face pushback from her caucus if she sought to schedule such a vote.
There’s a third option: Instead of raising the debt ceiling, Democrats could try to suspend the limit for another year, either through a stand-alone vote or as part of an unrelated bill.
The upside here? Avoiding a tough vote to increase the limits on the federal debt, made all the more difficult by Democrats’ meager majorities.
The downside? A one-year suspension would need to pass both chambers, and the Senate’s 60-vote threshold means Republicans could hold up the bill’s passage until they win concessions from Democrats on any number of other issues.
Asked to comment on this story, a spokesman for Senate Majority Leader Chuck Schumer, D-N.Y., referred CNBC to remarks the senator made in May.
“You know, I think it’s an absolute disgrace that the Republicans are using the debt ceiling, which deals with the financial security, as sort of a political issue,” Schumer said at the time. “We should get something done in the right way.”
A spokesman for the House speaker’s office did not reply to CNBC’s request for comment.
The vote isn’t a cakewalk for Republicans, either. While Democrats often face criticism for spending, members of the GOP are vulnerable to similar attacks from challengers in their own party during primaries.
“There are many Republicans who are looking over their shoulders,” said Block, the Fundstrat policy strategist. “They know they run the risk of a Republican opponent in a primary winning against them as an irresponsible spender.”
Representatives for Senate Minority Leader Mitch McConnell, R-Ky., and House Minority Leader Kevin McCarthy, R-Calif., did not immediately respond to CNBC’s request for comment.
Block is betting that Democratic leadership will try to include the debt ceiling provision in a large bill, such as the current infrastructure deal.
That approach, he said, not only allows Republicans to save face by offering them a reason to vote for it, but it puts pressure on progressive Democrats who may otherwise demand even more from an infrastructure plan that excludes funding for climate change or social programs.
“It’s just really difficult to put the obvious structural essentialities of increasing this to the politics of your member” of Congress, Block said. “Almost every staff member’s primary concern is getting their member elected, saving their job.”
— Thomas Franck reported from New York, and Christina Wilkie from Washington.