The Debt-Ceiling War: Wall Street Could Be a Casualty

When the new Congress meets for the first time this week, debt and government spending will sit firmly at the top of its agenda. Unlike past debates, this one could have a chilling effect on Wall Street -- as worried traders wonder if the U.S. could end up on the same chaotic economic path taken by Greece or Spain.

No one really thinks the U.S. can't pay its bills anymore. But a threat by some Republicans to vote against raising the debt ceiling -- currently at around $14 trillion -- could cause major headaches for investors in the near future. The government is expected to hit that ceiling at some point in the next few months, possibly as early as March.

Playing a "Game of Chicken"

"Wall Street owns the government bonds and the debt of Fannie Mae and Freddie Mac, all of which are going to be plunging in value in the event a debt default becomes a reasonable possibility," says Dean Baker, co-director of the Washington D.C.-based Center for Economic and Policy Research. "The idea that these assets might be worth less than 100 cents on the dollar would be a huge hit to their bottom lines."

Alan Brill, a research fellow at the American Enterprise Institute in Washington, agrees that at some point -- even though the markets know U.S. debt will eventually get issued -- investors are going to become more wary. "For the guys who live off short-term paper, there is going to be a little more of a risk premium there," he says.

Baker acknowledged the Republicans appear to be engaged in a "game of chicken" -- in which the Obama administration and the Tea Party wing of the Republicans each wait to see who will flinch first -- and then agree to concessions to get the debt ceiling raised.

Showdown in the Senate

Speaking on the Sunday talk shows, Austan Goolsbee, chairman of the White House Council of Economic Advisers, warned the debt ceiling was not a game to be played with. "If we hit that debt ceiling, that's essentially defaulting on our obligations, which is totally unprecedented in our history," he said. "The impact on the economy would be catastrophic."

Goolsbee's warning followed an announcement by Sen. Jim DeMint (R-S.C.) that he was planning a confrontation in the Senate to force Obama to cut spending. "We need to have a showdown at this point that we are not going to increase our debt ceiling any more," said the senator, who has a lot of support from the Tea Party faction and even some mainstream Republicans.

But analysts are divided about whether, politics aside, such a forced cut would be a good thing for the overall economy.

Brill is in the camp that says such a cut is necessary. "We want the market to be of the opinion that we are on a sustainable path," he says. "The question is: Is there some spending now that could be so good for the economy that it would outweigh the consequences of having an unsustainable path? I think the answer is no."

No Consensus on Forced Cuts

Brill says the administration should cancel all funding in the 2009 stimulus package that remains unspent, especially for projects -- like the high-speed rail -- that could end up costing much more over the long term.

But Baker vehemently disagrees, saying a forced cut now would seriously undermine the nascent recovery. "No doubt it's going to lead to a deeper recession," he says. "Right now the public sector is supporting the economy."

The argument that public sector spending is crowding out private sector growth isn't true, Baker claims. He believes the Fed should substantially expand its balance sheet and buy up much of the deficit, just as it did recently with other government bonds in a program called quantitative easing. By buying $4 trillion to $5 trillion in debt, he says, the government would effectively be paying itself the interest owed -- and thus avoid hurting the budget.

He points to Japan, where that nation's central bank holds an amount of government debt equal to the country's entire GDP with no apparent adverse consequences on interest rates.

As the new Congress gets deeper into the debt-ceiling debate, Wall Street will certainly be paying close attention.

Increase your money and finance knowledge from home

What are Penny Stocks

The lucrative and dangerous world of penny stocks.

View Course »

Small Cap Investing

Learn now to invest in small companies the right way.

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:

Could anyone tell me how much money is being spent daily on foriegn aid and how much is spent on defense daily I havent been following any of this and would just like to know what the government is giving to foriegn countries when they are talking of cutting social security in our country and for my own info isnt social security money paid in by the people and to be paid back to the people who paid it in and if so why would the government even think about messing with these peoples money if anything give them there money and let them lose it if they chose to why should the government be able to play with money they dont have any right to spend I thought I could be wrong but isnt social security just as it sounds security , it really sounds more like spending by the government that may be paid back thatts not very secure anyways just wondering maybe i should know more of what is going on before i ask but I need to know if I am even close too what is going on thank you

June 30 2011 at 12:16 AM Report abuse rate up rate down Reply

30 year mortgage intrest rates need to go to 2 1/2 to 3 1/2 percent to save the housing industry and prevent a DEPRESSION.

January 07 2011 at 12:53 AM Report abuse +2 rate up rate down Reply

There is NO INFLATION in the USA, Demand is low, and supply is high.

January 07 2011 at 12:52 AM Report abuse rate up rate down Reply

If Defense spendingand foreign aid are not reduced by 60 to 80 percent now. The USA will go bankrupt.And that's a fact, you can bank on it.

January 07 2011 at 12:50 AM Report abuse +1 rate up rate down Reply

Gold and silver are not the answer either. If all the untapped mines were opened and mining for those two metals alone went into full speed, there would be so much gold in the supply side, it would easily go down to $100.00 an oz. The supply of both gold and silver are controled by the mining companies by either mining or not mining. Therefore, the mining companies also control the demand and price valuations of it. Consider this world wide, and one realizes there is about as much value in gold and silver as there is in the dollar, Euro, yen, etc. The only realities are inflation and deflation. The price people want to put on it will be the price paid if demanded. Economics 101

January 06 2011 at 11:10 PM Report abuse rate up rate down Reply

Obuma is screwing every person that holds a dollar. and most people can't see or understand it.

January 06 2011 at 10:45 PM Report abuse -3 rate up rate down Reply

Amazing how little we seem to understand the debt ceiling. It is merely a limit on how much we can borrow. If we cared enough to pay for what we want then the debt ceiling would be irrelevant. Obama should have demanded ironclad guarantees of Republican support before he agreed to the new tax cuts and the rest of that huge spending package which added nearly a trillion to the debt. Having spent the money it is a little late to cry about the debt ceiling and threaten default. Maybe we can plan ahead in the future and not spend money we don't have?

January 06 2011 at 8:19 PM Report abuse rate up rate down Reply
7 replies to clark8642's comment

i know you've noticed that when these moonbats disappear for a couple of minutes....ALWAYS there comes more of 'em----now tell me something here----do they summon more or simply switch screen names over and over ????????

January 06 2011 at 5:06 PM Report abuse +2 rate up rate down Reply
2 replies to inyerfaace's comment

email all their buddies or multiple browsers

January 06 2011 at 5:08 PM Report abuse +3 rate up rate down Reply

I thought they were all going to the restroom together.

January 06 2011 at 5:22 PM Report abuse +2 rate up rate down Reply

"After years of historic deficits, this 110th Congress will commit itself to a higher standard: Pay as you go, no new deficit spending,” she said in her inaugural address from the speaker’s podium. “Our new America will provide unlimited opportunity for future generations, not burden them with mountains of debt."

January 06 2011 at 4:59 PM Report abuse +3 rate up rate down Reply

When Pelosi was sworn in on Jan. 4, 2007, the national debt stood at $8,670,596,242,973.04. At the close of business on Jan. 4, 2011, her last full day in the speakership, it stood at 14,014,049,043,294.41--an increase of $5,343,452,800,321.37.

January 06 2011 at 4:57 PM Report abuse +3 rate up rate down Reply