Debt-Ceiling Lessons from 2011

For a time, the current debt-ceiling debate was pushed to the back burner, but it returned to the center of attention May 1, when Treasury Secretary Janet Yellen said the United States could run out of money to pay its bills by June 1 (dubbed the “X-date” by the press) if Congress does not raise or suspend the debt limit.

Dire predictions of stock market turmoil, drastic interest-rate changes, failure to pay interest on government bonds, a severe recession, or even not making Social Security payments should Congress fail to raise the debt limit appeared everywhere.

Chart 1: S&P 500 Index, 2011

And so, it was in many of the previous 78 times when there was a threat that the U.S. might fail to pay its bills. The 2011 experience probably offers the best comparison to what is unfolding now.

Much like what is happening now, the Republican Party gained control of the House of Representatives in January 2011. This led to a confrontation with President Barack Obama, who was in the third year of his first term in the White House. Having to negotiate over deficit reduction in exchange for an increase in the debt ceiling was not an ideal situation if Obama desired a second term.

The 2011 debate went right to the brink. An agreement was reached only two days before the date the U.S. would not be able to pay its bills. This, however, was far from the end of the turmoil. For the first time in the country’s history, Standard & Poor’s downgraded the credit rating of the U.S. government, and the stock market faced intense volatility. From the May 24, 2011, close, the S&P 500 fell 20.6% to its ultimate intraday low on October 4, 2011 (see Chart 1).

You might think the 2011 lesson was enough to avoid another debt-ceiling problem, but only 18 months later, the United States reached the debt ceiling of $16.394 trillion that Congress enacted following the crisis in 2011. Investors, however, might have learned from the 2011 experience. Instead of falling sharply as it did in 2011, the S&P 500 moved steadily higher through all of 2013 (see Chart 2). The S&P 500 did not incur a notable pullback until the middle of 2015

Chart 2: S&P 500 Index, 2013

From an investment standpoint, the key question is: What to do now? Considering the wide range of possibilities, for most people, the best answer simply is, “nothing.”

We would not discount the potential that this entire problem might simply be put off to a future date by Congress approving a short-term debt-ceiling boost that would extend the debate to later this year.

Although hope abounds that sanity will prevail and brinksmanship will be avoided, this outcome is far from assured.

If a deal is reached, the market might lurch higher, which would mean higher prices for some stocks. At that point, the market’s path would not be littered with a huge political pothole.

If, however, a repeat of 2011 is in the offing, it is important to remember that the market aftershock lasted only five months, which in the context of a long-term investment program is relatively brief. It also could unlock investment opportunities at attractive prices.

Stay tuned.