U.S. Hits Debt Limit, Sky Doesn't Fall

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The U.S. hit its debt limit of $14.3 trillion on Monday -- and the sky didn’t fall.

Instead, the Treasury Department initiated the first of what promises to be a series of fiscal sleights of hand to stave off the long-threatened default of U.S. debt and the ensuing economic catastrophe promised if default occurs.

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Specifically, Treasury Secretary Timothy Geithner told Congress that he’s suspending investments in federal retirement funds until Aug. 2 to give the government a bit of wiggle room so that it can continue to borrow and pay its other bills.

By law, if the U.S. government surpasses the debt limit it can no longer borrow additional money to pay its obligations.

Phillip Swagel, an economics professor at the University of Maryland and a former assistant secretary in the Treasury Department, described Geithner’s announcement as “an accounting gimmick or an accounting maneuver, choose your word.”

Essentially, it’s money the government owes itself, Swagel explained, which makes it easier to suspend the payments than if it was money owed to another country, for instance.

The fund impacted, called the Civil Service Retirement and Disability Fund, provides benefits to retired and disabled federal employees covered by the Civil Service Retirement System, according to a fact sheet provided by the Treasury Department.

The fund is comprised of special Treasury bonds whose value is counted against the debt limit. So Geithner has suspended issuance of those bonds until at least until Aug. 2, which keeps the U.S. borrowing at a level below the debt ceiling. Treasury said suspension of those notes will provide the government with $17 billion in “headroom” below the debt limit.

Geithner assured Congress that the fund will be “made whole” once the debt limit is raised and that federal retirees and employees won’t be impacted.

Treasury also noted that “these extraordinary measures” have been used five times in the past 20 years -- in 1996, 2002, 2003, 2004 and 2006 -- as the ceiling loomed while Congress debated over whether or not to raise the debt limit.

Geithner has held up Aug. 2 as a sort of doomsday, a deadline by which Congress must agree to raise the debt limit or else the U.S. will be forced to start defaulting on its debt.

Swagel said it’s a smart move. While “establishing a hard and fast deadline” may limit Geithner’s flexibility, it could serve as a catalyst for pushing Congress toward a vote on raising the ceiling, he said.

Nearly everyone -- economists, academics and politicians of all stripes -- agrees that the U.S. shouldn’t risk default. Such a threat could freeze global credit markets if all of the parties who are owed money by the U.S. thought they weren’t going to be paid what they are owed. Those parties in turn couldn’t pay their own debts and so on down the line.

But the risk of that happening is minimal as Congress is likely to pass an increase once both Republicans and Democrats have made their respective political points. Fiscal conservatives, for example, have argued for months that any agreement move to increase the debt limit should be accompanied by spending cuts in an effort to strike at the heart of the problem – rapidly escalating budget deficits.

In any event, the U.S. government has plenty of flexibility in how it pays its bills so there is little immediate risk of an economic meltdown.

“The economy isn’t going to collapse and people aren’t going to be told to stay home if the debt ceiling isn’t lifted by Aug. 2,” said Jay Ritter, a finance professor at the University of Florida.

At the same time, it won’t help the U.S. credit rating, nor will it encourage global investors to flock to U.S. bonds if they believe there’s a chance the notes won’t be covered, said Ritter.

For the time being, Geithner is expected to continue to juggle which bills get paid and which don't.

Ritter also commended Geithner for setting the Aug. 2 deadline. “There’s nothing like a deadline to prompt politicians into making the hard decisions,” he said.

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