27 Jan 2023 Measuring the Risk of Default in the Debt Ceiling Crisis
Authored by RSM US LLP, January 27, 2023
The standoff over raising the federal government’s debt ceiling is not the first time that members of Congress have threatened to default on payments of existing U.S. public debt.
During past episodes, the policy brinksmanship has pushed up the cost of financing, caused a selloff in equity markets and led to a general decline in corporate and public confidence.
Both the public and financial markets tend to approach potential debt ceiling crises with a certain amount of skepticism and fear. One cannot simply ignore the current debt ceiling debate as talk or the price of negation.
While one should tread gingerly when attempting to extrapolate political rhetoric onto a likely response through financial markets, there is now evidence that this political discord is raising the cost of issuing public debt and increasing financial stress.
In our estimation, it will be some time—we think between August and October—before the U.S. government reaches a date that risks default. But there are already signs that the political polarization is resulting in financial stress.
Consider the one- and three-year U.S. credit default swaps, which have already spiked above levels of previous financial and political crises.
The CDS market is a vehicle for passing the increased risk of corporate default onto another party more willing to take on that risk.
For instance, a business lender might consider that the interest rate on existing holdings is no longer adequate compensation for the increased risk of an economic slowdown and the increased risk of default by corporate borrowers. The CDS market offers additional insurance for that risk.
Now, the cost of a one-year CDS is substantially higher than a three-year contract, implying a greater risk of default within the next year than in the next three years. Note, however, that the risk of further disruptions within the current term of Congress remains elevated.
This is not the first time for such an increase. The spike in the cost of protection offered by the CDS market in these recurring episodes is an indication of the effect of political discourse on the economy.
Just the threat of a U.S. default will have an impact on financial conditions and financial stability, which diminishes the ability of the business sector to borrow and lend, and will disrupt the normal course of the business cycle.
DO YOU HAVE QUESTIONS OR WANT TO TALK?
Fill out the form below and we’ll contact you to discuss your specific situation.
This article was written by Joseph Brusuelas and originally appeared on 2023-01-27.
2022 RSM US LLP. All rights reserved.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Haynie & Company is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.