2011 United States debt-ceiling crisis

The Republican Party, which gained control of the House of Representatives in January 2011, demanded that President Obama negotiate over deficit reduction in exchange for an increase in the debt ceiling, the statutory maximum of money the Treasury is allowed to borrow.

On July 31, two days prior to when the Treasury estimated the borrowing authority of the United States would be exhausted, Republicans agreed to raise the debt ceiling in exchange for a complex deal of significant future spending cuts.

Congress also usually votes on increasing the debt limit after fiscal policy decisions affecting federal borrowing have begun to take effect.

[3] In the absence of sufficient revenue, a failure to raise the debt ceiling would result in the administration being unable to fund all the spending which it is required to do by prior acts of Congress.

In addition, the Obama administration stated that, without this increase, the US would enter sovereign default (failure to pay the interest and/or principal of US treasury securities on time) thereby creating an international crisis in the financial markets.

Initially, nearly all Republican legislators (who held a majority in the House of Representatives) opposed any increase in taxes and proposed large spending cuts.

Supporters of the Tea Party movement pushed their fellow Republicans to reject any agreement that failed to incorporate large and immediate spending cuts or a constitutional amendment requiring a balanced budget.

[15][16] Critics have argued that the debt ceiling crisis is "self-inflicted,"[17] as treasury bond interest rates were at historical lows, and the US had no market restrictions on its ability to obtain additional credit.

Since then, the figure has shot upward: By the end of fiscal year 2011, the Congressional Budget Office (CBO) projects federal debt will reach roughly 70 percent of gross domestic product (GDP) — the highest percentage since shortly after World War II."

The sharp rise in debt after 2008 stems largely from lower tax revenues and higher federal spending related to the severe recession and persistently high unemployment in 2008–11.

[23][24] The Tea Party movement helped usher in a wave of new Republican office-holders in the 2010 mid-term elections[25] whose major planks during the campaign included cutting federal spending[26] and stopping any tax increases.

[35] Such low rates, outpaced by the inflation rate, occur when the market believes that there are no alternatives with sufficiently low risk, or when popular institutional investments such as insurance companies, pensions, or bond, money market, and balanced mutual funds are required or choose to invest sufficiently large sums in Treasury securities to hedge against risk.

[36][37] Lawrence Summers and other economists state that at such low rates, government debt borrowing saves taxpayer money, and improves creditworthiness.

[36] In January 2012, the U.S. Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association unanimously recommended that government debt be allowed to auction even lower, at negative absolute interest rates.

[40] This method of negative real interest rates has been claimed to be a form of financial repression by governments as it is "a transfer from creditors (savers) to borrowers (in the historical episode under study here—the government)" and "given that deficit reduction usually involves highly unpopular expenditure reductions and (or) tax increases of one form or another, the relatively 'stealthier' financial repression tax may be a more politically palatable alternative to authorities faced with the need to reduce outstanding debts".

While some leading economists, including Republican adviser Douglas Holtz-Eakin, suggested even a brief failure to meet US obligations could have devastating long-term consequences, others argued that the market would write it off as a Congressional dispute and return to normal once the immediate crisis was resolved.

"[53] Geithner responded that prioritizing debt would require "cutting roughly 40 percent of all government payments", which could only be achieved by "selectively defaulting on obligations previously approved by Congress".

He argued that this would harm the reputation of the United States so severely that there is "no guarantee that investors would continue to re-invest in new Treasury securities", forcing the government to repay the principal on existing debt as it matured, which it would be unable to do under any conceivable circumstance.

"[54] On January 25, 2011, Senator Toomey introduced The Full Faith And Credit Act bill [S.163[55]] that would require the Treasury to prioritize payments to service the national debt over other obligations.

[77] Some prominent liberal economists, such as Paul Krugman, Larry Summers, and Brad DeLong, and prominent investors such as Bill Gross, went even further, and argued that not only should the debt ceiling be raised, but federal spending (and, therefore, the deficit) should be increased in the short term (as long as the economy remains in the liquidity trap), which they believed would stimulate the economy, reduce unemployment, and ultimately reduce the deficit in the medium to long term.

"[77] Jack Balkin, the Knight Professor of Constitutional Law and the First Amendment at Yale Law School, suggested two other ways to solve the debt ceiling crisis: he pointed out that the US Treasury has the power to issue platinum coins in any denomination, so it could solve the debt ceiling crisis by simply issuing two platinum coins in denominations of $1 trillion each, depositing them into its account in the Federal Reserve, and writing checks on the proceeds.

[81] In a report issued by the credit rating agency Moody's, analyst Steven Hess suggested that the government should consider getting rid of the limit altogether, because the difficulty inherent in reaching an agreement to raise the debt ceiling "creates a high level of uncertainty" and an increased risk of default.

"[82] Other public figures, including Democratic ex-President Bill Clinton and Republican ex-CBO director Douglas Holtz-Eakin, have suggested eliminating the debt ceiling.

[74] They point to Section 4 of the Fourteenth Amendment to the US Constitution, passed in the context of the Civil War Reconstruction, that states that the validity of the public debt shall not be questioned.

[96] Hence it has been suggested that a coin with a face value of a trillion or more could be minted and deposited with the Federal Reserve and used to buy back debt, thus making funds available.

[110] The NASDAQ, ASX, and S&P 100 lost up to four percent in value, the largest drop since July 2009, during the Great Recession that was precipitated in part by the United States housing bubble and the corresponding losses by holders of mortgages and mortgage-backed securities.

In contrast with previous ratings, the agency assumed in the base case scenario that the tax cuts of 2001 and 2003 would not expire at the end of 2012, citing Congressional resistance to revenue raising measures.

The downside scenario, the conditions that would likely lead to a further downgrade to AA, assumed that the second round of spending cuts would fail to occur and that yield on Treasury bonds would increase but the dollar would remain the key global reserve currency.

The upside scenario, consistent with maintaining the new AA+ rating, included the expiration of the 2001 and 2003 tax cuts and only modest growth in government debt as a percentage of GDP over the coming decade.

[113][114][115] A week later, S&P senior director Joydeep Mukherji said that one factor was that numerous American politicians expressed skepticism about the serious consequences of a default—an attitude that he said was "not common" among countries with a AAA rating.