Debt Ceiling Issues: Crisis or Media Frenzy?

Financial Planners like myself have been praying for our government officials to solidify the debt ceiling issue as soon as humanly possible. Following the reports in the media might lead one to believe that the pigs are starting to grow wings!

The reality is far more somber.  First, one must consider the effect upon the global economy by the US Government Bond ratings dropping.  Most institutional investors, and private investors too, hold a certain percentage of their portfolios in “safe” positions.  

In your lifetime, would you ever have considered US Treasuries to be anything less than the safest investment possible?  Of course not! Neither has any foundational theory of investing.  One always has a certain portion of his portfolio in cash or cash equivalent positions, a certain portion in bonds, and so forth.  Now, if the government does not raise the debt ceiling by August 2, 2011, the following COULD, but not necessarily WILL happen:

First, the US Bonds will carry a lower rating by all the rating companies.  This has a direct impact upon each and every portfolio, whether private or institutional.  Why?  Because money market funds, which use as their basis the Treasury rates, might no longer be able to claim themselves as “cash equivalent” according to Investopedia, are defined as

Cash equivalents are one of the three main asset classes, along with stocks and bonds. These securities have a low-risk, low-return profile. Cash equivalents include U.S. government Treasury bills, bank certificates of deposit, bankers' acceptances, corporate commercial paper and other money market instruments.

Now, should the US government treasury bonds no longer carry the “high credit quality” moniker, every portfolio will have to be redefined. Ironically, many will make a beeline to their financial planner’s phone and move to the “cash” positions.  While it is true that stocks will take a hit over this issue.  Once the world settles back in, stocks will make their come back as always. 

Others will return to the real estate market.  The challenge there is that mortgage rates, which are loosely tied to the 10 year note (I say loosely because there is a correlation, but it is not actual in that mortgage rates are determined by market forces which include, but are not limited to the treasuries).  

Investors who are buying mortgage backed securities will definitely want a higher rate of return since their previously “safer” investments (Treasuries) will have to pay higher rates to win the investment dollars.  Some predictions have rates over 8% by October and some are even calling for double digits.  I’m not one who believes this will occur, but if we listen to some of the media stories of doom and gloom, we should all be jumping off buildings by year end.

What should we reasonably expect to happen?  Well, clearly there will be negative economic impact.  Will we find ourselves in the same position as Greece?  Not a chance!  However, we could see interest rates rising.  We could see commercial and residential starts, stopping. We could see developers unable to obtain financing for projects already in progress.  We could see higher costs of goods as the cost of financing rises.

Hopefully, our leaders will overcome their politicking and look towards the best interests of the country.  Both sides of the aisle are right and wrong, financially speaking.  Whatever happens, we should have some resolution soon.