If the United States government cannot pay all its bills because of a debt ceiling impasse, household borrowing costs could soar, the job market could shed millions of jobs and stock-market valuations could shrink, according to estimates of economic life after a default.
The projected consequences of a prolonged default sound grim, according to Moody’s Analytics. The estimated fallout from a brief default is less severe, but still enough to push the “already-fragile” economy into a mild recession, Moody’s says.
On Wednesday, Treasury Secretary Janet Yellen said it’s “almost certain” that the Treasury will run out of resources in early June, and said she will provide a new update on the debt-limit deadline “pretty soon.”
For all the uncertainties, financial experts say there are still ways to prepare. Make sure your deposits are in accounts backed by the Federal Deposit Insurance Corporation, and think hard about rate-sensitive purchases like a car or a house.
It’s important to have a plan in the off-chance of a default, said Rob Williams, managing director of financial planning, retirement income and wealth management at the Schwab Center for Financial Research, a division of Charles Schwab & Co
SCHW,
“On Wednesday, Treasury Secretary Janet Yellen said it’s ‘almost certain’ that the Treasury will run out of resources in early June.”
“Having a financial plan in place that looks at the long and short term is the best way to prepare for the debt ceiling or any other crisis,” he said.
To be clear, there is still widespread expectation that Congress will strike a political deal that lifts the federal government’s $31 trillion borrowing limit. President Joe Biden and House Speaker Kevin McCarthy met Monday, and more talks are planned.
But the time to act is dwindling. It’s “highly likely” that early June, even June 1, is the moment when the government gets to the point where it cannot pay all its bills and debt obligations, Yellen said this week.
Meanwhile, new Federal Reserve figures offer a reminder that Americans’ personal finances over the last year have been under pressure, even as inflation rates retreat slowly.
More than one-third of people, 35%, said they were worse off in 2022 than a year earlier, according to the Fed’s annual look at economic well being released Monday.
That’s the largest percentage of people saying they were worse off since central bank researchers started asking the question nearly a decade ago.
“If there ever was a time for a rainy-day fund, this is it. But it’s not going to be able to help a lot of consumers,” said Rachel Gittleman, financial services outreach manager for the Consumer Federation of America.
For example, Social Security payments and payments to veterans could be delayed in the wake of a default, she said. “There will be a lot of consumers who will be in an impossible financial situation,” Gittleman said.
Make sure your money is safe
The FDIC guarantees deposits up to $250,000 on accounts including checking, savings and certificates of deposit. Nothing changes in the wake of any default, an FDIC spokesperson told MarketWatch.
FDIC coverage came into hard focus during early spring when Silicon Valley Bank and Signature Bank closed, putting other regional banks under pressure as many customers moved their money into megabanks.
If economic conditions deteriorate after a default, Gittleman said people will want assurance their money is safe. If you haven’t taken any of the recent bank failures as a sign to put money in an FDIC-insured account, “this would be the time,” he said.
Start cutting costs quickly
During the early days of the pandemic when there were millions of job losses, many people had to quickly cut and/or delay regular expenses.
If a default puts people in an economic vise, Gittleman said they may need to be ready to shut down non-essential recurring payments and talk with their lenders and credit-card companies. “It’s thinking holistically about all of your financial expectations and where you can possibly either get forbearance or some leniency and ask for some help,” she said.
Credit-card debt reached $986 billion in the first quarter, according to the Federal Reserve Bank of New York. Delinquencies on credit cards and car loans continued their move higher after pandemic lows.
Rate-sensitive purchases
It’s already a tough time to finance a major purchase after more than a year of rising interest rates. On Tuesday, a 30-year fixed mortgage climbed back past 7% for the third time this year.
Any default spanning at least a month would push the 30-year mortgage up to 8.4% in September and price out hundreds of thousands of buyers, according to Zillow
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That is still no reason to speed a home purchase, said Daniel Milan, founder and managing partner of Cornerstone Financial Services.
“Any default spanning at least a month would push the 30-year mortgage up to 8.4% in September and price out hundreds of thousands of buyers, according to Zillow.”
The Federal Reserve doesn’t set mortgage rates, but its policies influence their direction. The big question for the Fed is when the central bank stops increasing its benchmark rate and when it reduces the rate.
“The odds of a rate cut outweigh the fear or the rush into buying a home now because of the debt-ceiling crisis,” Milan said.
But trying to time a major financial decision around market and political events is a difficult task, Williams added.
Financial decisions are a mix of math and emotions even if many people tend to focus more on the math, he said. That’s why it’s important to figure out a financial plan. Oftentimes, the best course is to stick to your plan and say, “I’m not going to make major changes in the face of market news,” Williams said.
Portfolio protection
The Dow Jones Industrial Average
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the S&P 500
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and the Nasdaq Composite
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closed sharply lower in volatile trading on Tuesday, and opened lower Wednesday. It’s the Dow’s third straight trading-day loss.
The yields on short-term Treasury debt maturing in early June are pushing towards 6% amid continued uncertainty about whether a debt-ceiling resolution can come together fast enough to avoid a government default. Bond prices and yields move in opposite directions, reflecting less investor appetite for debt.
There’s no one rule for preparing an investment portfolio for a debt default, financial advisers said. But older, retired investors are in a trickier spot compared — especially in relation to the prospect of delayed Social Security checks — to younger investors who have more time to bounce back.
“‘We continue to urge clients to make sure we know about any short-term cash needs so that those funds are not at risk.’”
Cash investments have already proven attractive in rocky times. But the risk of a debt default could make a heftier cash allocation more important for older investors, financial advisers added.
“We continue to urge clients to make sure we know about any short-term cash needs so that those funds are not at risk,” said Lisa A.K. Kirchenbauer, founder and president of Omega Wealth Management.
Kirchenbauer said she’s starting to hear from concerned clients about their debt-ceiling concerns. “I am making sure that larger [required minimum distributions] are in cash for 2023 now, before anything bad happens in the markets.”
Required minimum distributions are the minimum yearly amounts that have to be pulled out of qualified retirement accounts once the owner turns a certain age, currently 73.
Preparing for any default is a mental exercise as much as asset allocation, said Amy Hubble, principal investment adviser with Radix Financial. If personal circumstances haven’t changed, like job status, income needs or retirement timeline, avoid getting sidetracked by short-term issues, she said.
“There are only a small handful of things we can actually control when investing,” Hubble added. “So my advice is always to focus on that: keeping costs low, staying diversified, managing tax-recognition timing, and avoiding stupid emotion-driven action.”
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