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Q&A: US debt-ceiling deal

02 August 11 04:32
The White House

Republican and Democratic leaders have reached a tentative agreement on raising the US debt limit and avoiding default.

A day after its passage by the House of Representatives, the bill is expected to be approved by the Senate on Tuesday and be signed by President Barack Obama, before becoming law.

What is the proposed deal?

Under the the agreement, the US deficit will be reduced by at least $2.1tn (£1.3tn) over 10 years. The ceiling for US borrowing will be raised by up to $2.4tn. A new Congressional committee to recommend further deficit-reduction measures is to be established and report back by November. Congressional leaders are hopeful the compromise will win the backing of both houses, but some Republicans and Democrats in the House of Representatives remain opposed for different reasons.

What is the debt ceiling?

There is a legal limit on the total amount of debts the US government can run up in order to pay its bills - including military salaries, interest on existing loans, and Medicare. The current limit is $14.3tn.

The cap was reached in May. Treasury Secretary Timothy Geithner was able to extend the expected day of reckoning to 2 August, by various tricks such as postponing payments into government pension schemes, and thanks to better-than-expected tax revenues.

Why can't the Obama administration borrow more?

Because it is not in Mr Obama's power. The debt ceiling is set by statute and can only be raised by Congress.

An overall borrowing cap was first introduced by Congress in 1917 to make it simpler for the government to finance its efforts in World War I.

Since then the ceiling has been raised dozens of times, and it is usually a formality.

Congress also sets the government's spending commitments and tax-raising powers.

This puts the Obama administration in the impossible position of being required to spend more than it earns, while also being prevented from borrowing the difference.

What is the problem this time round?

The financial crisis and the US's fragile economic condition have caused government spending to soar, while tax revenues have suffered.

This has caused a big rise in the government's deficit - its rate of borrowing.

The Republicans, who control the House of Representatives, say they want to bring the deficit back under control, and threatened not to raise the debt ceiling unless a deal was reached.

What have been the positions of both sides?

Both sides accept that cutting the deficit is vital. In recent weeks several plans have been floated by one side or another and been batted down.

The chief sticking points have been Republicans' resistance to tax rises and calls for much bigger spending cuts than the Democrats favour, and Democrats' desire to shield healthcare programmes for the poor and elderly and the Social Security pension programme from cuts.

A number of House Republicans - mainly newly elected staunch Tea Party fiscal conservatives - opposed raising the debt limit in any form.

What happens if no deal is reached by 2 August?

An unlikely scenario given that the bill has been passed by the House, and its approval by the Senate is viewed as all but certain. However, were the US to default, Tim Geithner said it would be "catastrophic", while President Obama warned it might tip America back into recession.

Economists say President Obama's options could include:

  1. Stopping payments across the board, including debt repayments. This would be a disastrous outcome for financial markets.
  2. Prioritising some payments (particularly interest payments), at least until money completely runs out. Some $23bn of social security payments due on 3 August could in theory be delayed. But these payments are computer-automated and may be technically impossible to stop. Moreover, stopping them would hurt core Democrat voters. And it is not even clear the government has the legal right to prioritise payments like this anyway.
  3. Ignoring the debt ceiling and continuing borrowing. Some have argued that the US constitution gives the president authority to do this. It would certainly spark a constitutional crisis, and possibly impeachment proceedings.

What do academics say would happen if the US defaulted?

Interest rates on credit cards, car loans and home mortgages would rise sharply, says George Washington University Professor Julius Hobson.

He adds that global financial institutions around the world holding AAA-rated US Treasury notes and bonds would see the value drop.

Harvard University Economics Professor Jeffrey Miron says foreign creditors could start withdrawing money from US banks.

He also says cheques could be delayed to social security beneficiaries.

Surely the US would not default on its debts?

So far that has been everyone's assumption.

The US has not seen any significant increase in its borrowing cost, in the way that Greece and other indebted eurozone governments have.

The rating agencies are somewhat less relaxed. On 15 July, Standard & Poor's warned it could cut the US's coveted AAA credit rating if no deal is done, which could limit some investors' ability to lend to the US government.

Moreover, some analysts point out that a surprisingly large amount of existing debt comes up for repayment later in 2011 - some $1.7tn, or 12% of its total debt.

They fear that investors could panic and refuse to relend the money, forcing a default.

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