What is the difference between a government shutdown and hitting the debt ceiling?
In a government shutdown, Congress and the President do not enact interim or full-year appropriations for government agencies that rely on discretionary funding. As a result, these agencies do not have budget authority available for obligations such as salaries or rent. Under the Antideficiency Act,1 agencies may obligate some funds in certain “excepted” areas, but these obligations are highly restricted. Agencies must shut down non-excepted activities, and the federal government may not make actual payment for excepted or non-excepted activities until budget authority is provided.
In a debt limit impasse, the government no longer has an ability to borrow to finance its obligations. Consequently, the federal government needs to rely solely on incoming revenues to fund itself. During periods where the federal government is running a deficit, the dollar amount of newly incurred federal obligations exceeds the dollar amount of newly incoming revenues. In such a situation, provided that appropriations are in place, an agency has budget authority available for obligation and may continue to obligate funds. Currently, however, appropriations for such obligations do not exist, given the lack of a continuing resolution for the current fiscal year.
What is the significance of October 17th? If the debt ceiling is not raised by then, will the US be in default on October 18th?
The Treasury has estimated2 that it will have exhausted all “extraordinary measures,” such as suspending investment in federal employee accounts and stopping issuance of State and Local Government Series (SLGS) securities,3 by October 17th.4 At that point, the Treasury calculates that it will have a cash balance of just $30 billion. The CBO estimates5 that government spending for its ongoing programs and activities is likely to average about $10 billion a day, but that several major outflows are due within the coming weeks: 1) October 16 and 23—Social Security benefit payments (about $12 billion each), 2) October 31—payment of interest on Treasury securities (about $6 billion), 3) November 1—payments of Social Security benefits (shifted from the third of the month, which falls on a Sunday); payments to Medicare Advantage and Medicare Part D plans; pay for active-duty members of the military; and benefit payments for civil service and military retirees, veterans, and recipients of Supplemental Security Income (about $67 billion in total), 4) November 13—payments of additional Social Security benefits (about $12 billion), 5) November 15—quarterly payment of interest on Treasury securities (about $30 billion). While the Treasury will continue to receive inflows in the form of employer remittances from income and payroll taxes withheld from paychecks, those remittances typically average about $7 billion per day. By CBO’s estimate, depending on the amount and timing of cash flows, the Treasury might be unable to fully pay its obligations anytime from October 22 onward.
What is the effect of the uncertainty caused by the potential for default on commercial real estate?
The main effect of a potential default on commercial real estate is through the interest rate channel; the secondary impact is a decline in business confidence, and a subsequent slowdown in hiring and investment, which would curtail commercial real estate demand. Already, the cost of insuring against a US default via the credit default swap market has risen, and Treasury bills that mature at the end of October now yield substantially more than longer-dated bills that mature in mid-November (Chart 1), reflecting the increased probability of a near-term default. (Typically, yields on shorter-maturity debt are lower than yields on debt with a longer maturity.)
Last week’s results from the National Federation of Independent Business showed that confidence among U.S. small businesses (those with 500 or fewer employees) fell in September to the lowest level in three months, while today’s Empire State Manufacturing Survey release from the Federal Reserve Bank of New York showed a decline in the general economic index to a five-month low. Amid a period of already lackluster economic growth, businesses may opt to delay any evaluation of their real estate needs.
If interest rates rise, how will this affect corporations and commercial real estate firms?
Based on the Federal Reserve’s flow of fund accounts, the ratio of total liabilities to total assets for nonfinancial corporate businesses in Q2 2013 (the quarter for which most recent data are available) was 42.2%. However, commercial real estate entities generally employ a greater degree of leverage, as the balance sheets of several publicly-traded REITS show in Table 1. Commercial real estate ventures, in addition to banks, would be among the most susceptible businesses to higher borrowing costs.
How exposed are companies to short-term borrowing rates?
The Federal Reserve conducts a quarterly survey of business lending based on gross loan extensions, contacting 348 domestically-chartered commercial banks and 50 U.S. branches and agencies of foreign banks. Based on data collected during August 2013, of the $91.1 billion in total commercial and industrial loan extensions, $44.2 billion, or 48.5% of the loans, re-priced at least daily (Chart 2) suggesting that the risk from an increase in rates immediately would be felt for almost half of recent bank borrowings.
Additionally, as shown in Chart 3, a rise in effective Fed Fund rates and/or a rise in Treasury rates would be fairly significant, affecting borrowing costs via higher yields demanded for corporate bonds issued in the public debt markets (green line), or through higher rates on floating-rate bank loans (blue line), where borrowing costs have tended to be roughly 350 bps above the effective Fed Funds rate.
A default by the US on its debt (whether by failure to make timely interest and principal repayments or by a prioritization of its liabilities that results in repayment of some, but not all, of its obligations) is a low-probability event, albeit one with catastrophic repercussions, particularly against the backdrop of a government shutdown. The main impact of a default would be a rise in borrowing rates across the board—for individuals (via credit card and auto loans, as well as mortgages) and for corporations (via public debt markets and bank lending), while access to credit would likely be restrained for all but the highest credit-quality borrowers. With higher funding costs, businesses would reduce expenses such as labor, which would hamper consumption spending and push the economy into recession. (Already, the failure of Congress to adopt a continuing resolution has left roughly 400,000 federal employees—and several thousand private-sector workers from contracting firms including URS, Lockheed Martin and the Aerospace Corporation—on furlough, resulting in lost paychecks for workers and the loss of payroll tax revenue to the Treasury.) A default would both boost the cost of Treasury borrowing and weaken the US dollar, further pressuring rates as foreign holders liquidated their bond holdings.