Debt ceiling impasse has moved into troubling territory. On January 19, the United States reached the national debt ceiling of $31.38 trillion. At that point, the Treasury Department was no longer allowed to borrow money to finance previously-made spending decisions. Instead, the Treasury began pulling from a reserve of federal funds originally allocated for other expenses, in order to maintain government operations and service the nation’s outstanding debt. Paying interest to the various holders of U.S. debt is critical to maintaining the nation’s status as a reliable borrower and allowing the country to continue to access capital in the future. U.S. debt is also a benchmark for many financial instruments, and a default would likely send major shocks through capital markets. However, the Treasury’s reserves are quickly dwindling and may expire as soon as early June. At that point, the Treasury will not be able to fully fund the government, as federal expenses exceed incoming revenues. Congress and the president are negotiating a deal, but as the impasse moves up against that early June date, consequences are possible.

Close-call agreements are not unusual for the country. The U.S. has never experienced a major default in recent decades, but lawmakers have reached last-minute resolutions on several occasions. In 2011, the standoff persisted right up to the estimated date in which Treasury reserves were to be depleted, potentially serving as a guide for the current situation. That close call triggered the most turbulent week for capital markets since the Global Financial Crisis, as Standard & Poor’s downgraded the U.S. government’s credit rating for the first time in history. The byproduct of this caused the U.S. government’s borrowing costs to rise by an estimated $1.3 billion during that year. A contingency plan was also created to avoid default if reserves dried up, likely providing foresight for the path forward today if a resolution is not reached in time. The plan called for the Treasury to continue paying interest and principal on maturing debt, while cutting costs on all other obligations.

Government-funded programs may be cut if needed. The Treasury is likely to continue making debt payments, even if it exhausts funds to pay for other expenses. Veterans benefits, as well as social welfare programs, may be suspended, while federal employees could see a delay in their paychecks. The interruption may in turn prompt some agencies to scale back operations. In this way, a debt default would act like a government shutdown. A key difference is that a shutdown does not impede the nation’s ability to pay its debts; the very risk of which could increase lending costs not only for public debt instruments like Treasury Notes, but also the financial vehicles based on those benchmarks.

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Sources: Marcus & Millichap Research Services; Federal Reserve; Moody’s Analytics