July 2011 Newsletter: Debt & Default

Posted by on Jul 11, 2011 in MFA Insights

We wanted to share some of our thoughts on the upcoming August 2nd deadline to increase the US Government’s debt ceiling. It is very unfortunate that we are approaching the deadline without a resolution clearly in sight. Given the nature of current political debate, it appears that we won’t have a solution until the last minute, if then.

We haven’t seen too much thoughtful discussion of what might actually occur if the deadline passes with no action by Congress. This is not the first time our nation has been faced with this challenge. In 1957, the Federal government didn’t pay all of its creditors when due, not unlike the way that a typical household would manage the same situation. Payments to government contractors were delayed until a long term solution could be reached. In 1996, the threat of having to choose who to pay was enough to spur Congress into action. Unfortunately, that threat seems to carry less weight in the present day.

The next set of interest payments on US Treasury debt will be due on August 15th. Interest payments on US debt account for only 6% of the federal budget [defense, health programs and Social Security each account for more than 20%]. So there will be some room to hold payments in the other areas if Congress continues to drag its feet and still remain current on the debt. We are also hopeful that Congress’ scheduled recess after August 5th will provide further impetus to resolve the matter before legislators go home for the summer break.

Even though default doesn’t mean bankruptcy, the consequences if the US government were to default on its debt are potentially severe. One of the foundations of the global financial systems is the “risk free” nature of US government obligations. So far, the US Treasury bonds market has not anticipated a chaotic outcome as prices of the US Government’s ten-year benchmark bond have actually risen appreciably in the last two weeks. That’s not to say a surprise is not possible. We have reviewed possible strategies including the purchase of precious metals and each option seems to add its own costs and risks. For the time being, we intend to remain invested as agreed with you in our globally diversified portfolios.

More market turbulence should be expected as we approach the August 2nd deadline but we believe this should be a relatively short-term phenomenon. We feel our longer term portfolios are positioned to provide us the appropriate risk-adjusted return over time.

Please feel free to share with us your thoughts and concerns.


Tim Harrington, CFP® David N. Shore, ChFC