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What does the debt ceiling standoff mean for your finances and 401(k)?

What does the debt ceiling standoff mean for your finances and 401(k)?

FINANCIAL NEWS

What does the debt ceiling standoff mean for your finances and 401(k)?

Stock Market 101: Basic strategies investors use to profit off stocksBefore jumping into the market, here’s what first-time investors should know about stocks, capital gains and mistakes to avoid.For My Money, USA TODAYCongress has to raise the U.S. debt ceiling before Oct. 18, to prevent a first-ever default.It could mean a spike in mortgage rates and other consumer borrowing for AmericansGovernment funding and the debt ceiling are separate issues.It’s coming down to the wire for Congress to reach a deal on the national debt ceiling before the U.S. government runs out of money to pay its bills. If lawmakers in Washington, D.C., are unable to resolve the debt limit in time and the Treasury begins paying its bills late, the U.S. could default on its debt — something that has never happened.Lawmakers are at odds over raising the federal borrowing limit, or the debt ceiling, which allows the U.S. government to make good on its financial obligations. The debt ceiling, also referred to as the debt limit, or the amount the government can borrow, now stands at $28.4 trillion. The national debt, the amount the government owes its creditors, is $28.43 trillion.Congress has to raise the U.S. debt ceiling before Oct. 18, to prevent a first-ever default. In the meantime, the Treasury Department can meet financial obligations for a while using tax revenue and cash reserves.Separately, Congress has to pass a funding bill before midnight Thursday to avoid a government shutdown. Congress could take action Wednesday to fund the government.Failure to raise the debt ceiling would make it impossible for the federal government to keep its existing financial obligations that include payments to veterans and Social Security recipients. Republicans, who raised the debt ceiling under GOP President Donald Trump and prior administrations, are balking at doing so again under President Joe Biden, a Democrat. Senate Republicans have said Democrats should raise the debt ceiling themselves.So what does the latest political gridlock between Republicans and Democrats over the debt ceiling mean for your personal finances and investments? ►Your 401(k) and the stock market: It’s getting bumpy, but experts say don’t fret►Most Americans are afraid to invest in a stock market downturn: Here’s why that’s wrong.If the U.S. defaulted on its debt, it could create a scenario where the economy may plunge back into recession following massive pandemic-related disruptions to financial markets worldwide.The result: millions of job losses that had been recovered since the COVID-19 outbreak last year, according to financial experts.It could also mean a spike in mortgage rates and other consumer borrowing for Americans, at least until the debt limit is resolved and Treasury payments resume, experts say. Despite warnings of economic catastrophe, financial experts say the negative effects from the debt ceiling standoff would likely be limited for the economy and Americans’ pocketbooks because economists and analysts widely expect that a deal will be reached before the Treasury runs out of money.“For the moment, this is a situation to watch but not to panic about,” Brad McMillan, chief investment officer at Commonwealth Financial Network, said in a note. “The risks are real, but certainly not immediate, and even in the absence of a deal not as large as many fear.”Here’s what you need to know:What does the debt ceiling drama mean for financial markets?The U.S. Treasury said that the debt limit must be raised by Oct. 18, or it will exhaust the “extraordinary measures” it uses to manage the debt once the legal limit has been reached. At that point, the Treasury won’t be able to pay all of its bills. If the ceiling isn’t raised, the U.S. could default on its debt, making it more expensive for the Treasury to borrow money and could result in a credit rating downgrade.While markets might breathe a sigh of relief over averting a government shutdown, analysts note that there is no clear path to dealing with the debt ceiling.Government funding and the debt ceiling are separate issues.The federal government will shut down at midnight Thursday if lawmakers fail to approve a new funding budget. That could lead to thousands of federal worker furloughs and may shut down many national parks. It may also delay mortgage and other loan applications if the IRS is forced to stop verifying income and Social Security numbers.The debt ceiling, however, is viewed as a greater economic threat if Congress fails to suspend or raise the U.S. borrowing limit, which would result in a historic default and result in havoc for the financial system. Since neither party has a clear exit strategy, it could be a tense few weeks in Washington which could add to market volatility, analysts say. Financial markets, however, are still relatively calm despite a rise in volatility recently.That’s likely because it has become standard practice for Congress to run down the clock in these situations, but figure out a way to raise the debt ceiling in the end when absolutely necessary, experts say. It’s widely expected that Congress will do so again.“Given where we are in the economic recovery and since we’re not completely out of the woods with COVID and supply-chain issues, I think the government will avoid at all costs creating a political nightmare that would put more pressure on the economic recovery,” said Liz Young, head of investment strategy at SoFi, an online personal finance company.What does the debt ceiling gridlock mean for your 401(k)?If the debt ceiling is triggered, it would certainly be unchartered territory and lead to large instability in financial markets.Though long-term investors should stay the course and not let short-term events dictate their investment decisions, according to Michael Sheldon, chief investment officer and executive director at investment advisor RDM Financial Group at Hightower.“Like many of these crises in Washington over the past several years, calmer heads will likely prevail at the last minute,” said Sheldon. “For investors thinking long term who are putting away money for retirement, this will probably be short-lived, so you want to continue to focus on your long-term investment objectives.”These expectations may be stronger now than in times past since Democrats control both the executive and legislative branches of the federal government.Investors appear to believe this deadline won’t be as disruptive as those in 2011 and 2013, during prior budget stalemates in the wake of the global financial crisis.A debt ceiling impasse in the summer of 2011, for instance, caused Standard & Poor’s to downgrade the country’s credit rating by a notch to AA+, which added to market volatility that year.To be sure, this isn’t an economic crisis.The U.S. can borrow enough money to pay its bills. Instead, it is predominantly a political issue for now, according to Thomas Martin, senior portfolio manager at Atlanta-based GLOBALT Investments“The U.S. has never defaulted on its Treasury securities. It’s highly unlikely it will happen,” said Martin. “If it did, it would be a disaster.”“Most of this is political posturing,” Martin added. “Each party is trying to get the other side to get closer to what they want.”What is the economic fallout if the debt ceiling isn’t raised?The economic effects of such an unprecedented event would surely be negative for the current recovery, financial experts say. On Tuesday, Treasury Secretary Janet Yellen told Congress that the Treasury would be unable to pay all of the government’s bills if the debt ceiling isn’t raised by Oct. 18.“The full faith and credit of the United States would be impaired, and our country would likely face a financial crisis and economic recession,” Yellen said in remarks to the Senate Banking Committee this week. A U.S. default would be “potentially catastrophic” Jamie Dimon, chief executive of JPMorgan Chase, said in an interview with Reuters this week, adding that the country’s biggest lender has begun planning for how a potential credit default would affect the repo and money markets, client contracts and its capital ratios.“This is like the third time we’ve had to do this, it is a potentially catastrophic event,” he told Reuters.What does it mean for the economy? There is an “enormous amount of uncertainty” surrounding the speed and magnitude of the damage the U.S. economy will incur if the U.S. government is unable to pay all its bills for a time, according to the Brookings Institution, a nonprofit public policy organization.It depends on how long the situation lasts, how it is managed, and the extent to which investors alter their views about the safety of U.S. Treasurys, experts at Brookings say.An extended impasse is likely to cause significant damage to the U.S. economy, according to Mark Zandi, chief economist of Moody’s Analytics. If the U.S. actually defaults, there would be more damage that would upend the stock market. And if the impasse drags on, the government would actually have to cut spending, such as Social Security payments and the nation would be plunged back into recession with 6 million job losses, a 4% decline in gross domestic product and a 33% plunge in stock prices that would wipe out $15 trillion in wealth, Zandi added. “Since U.S. Treasury securities no longer would be risk-free, future generations of Americans would pay a steep economic price,” Zandi said in a note to clients. Even in a best-case scenario where the impasse is short lived, the economy would likely still face challenges, he added. If the U.S. doesn’t default, but investors worry about the nation’s ability to pay interest to Treasury holders and fund Social Security and all other obligations, it would likely push up interest rates for a brief period and hurt the economy. The debt ceiling impasse in 2013, for instance, ultimately cost the economy 1% in GDP by 2015 and there would have been 1.2 million more jobs, according to Zandi . Treasury yields, mortgage rates and other consumer and corporate borrowing rates would spike, at least until the debt limit is resolved and Treasury payments resume, Zandi explained. “Even then,” Zandi said, “rates never fall back to where they were previously.”Contributing: Paul Davidson, USA TODAY


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