This analysis is based on facts available on July 18, 2011. This is a rapidly changing situation that should be monitored aggressively. The best thing that could possibly happen is that the debt ceiling is raised before you read this.
Impact on Business and IT
For businesses that depend on the government for revenue, not resolving the debt ceiling means revenue is likely to be interrupted or diminished.
Expect to be shut-out if you are a non-essential services contractor. Essential services will most likely continue in a reduced government case.
The government represents about 24% of GDP. In a partial shutdown we would expect a decline of about 10% in overall business levels. Some government employees and suppliers will have trouble meeting personal financial commitments.
State and local governments will take up some of the federal slack, but many of those governments are severely financially stressed.
All of this means that IT will face unpredictable loads.
Managements and auditors will need considerable analysis of government receivables. Public companies will have to make decisions regarding these receivables before reporting third quarter results. Decisions regarding inventory, production, and employment levels for government supplying business units and a myriad of other cash flow factors would have to be re-examined. Quite possibly basic operating parameters built into ERP, CRM, supply chain, and other systems would need adjustment. Of course all of the above impact customer and supplier facing systems.
The press and politicians have overstated many of the issues surrounding resolving our debt-ceiling problem. Amid all the noise it is important to remember that no adjustment in the debt ceiling, government shutdown, and debt default are three different things. It is important to understand the differences and develop strategies for dealing with each.
1) No debt ceiling resolution means we would have to operate our government on current cash flow rather on new borrowings. A partial government means we, as a nation, will have to make some hard decisions about what to pay out of cash flow. 60% likelihood
2) Ratings downgrade seems likely almost whatever happens. Rating agencies have been on the defensive for several years and would rather be safe than sorry. We believe there is a 90% or higher likelihood.
3) A U.S. debt default would be devastating to world financial markets, our international relationships, and overall world standing. We think there is a less than 10% chance of a debt default.
4) A total government shutdown would be worse than defaulting on debt making chaos likely. We believe this less likely than a debt default, perhaps 2% at most.
Scenario 1 -- No debt ceiling resolution, partial government, 60% likelihood
It is likely we would rather pay our military, social security, and Medicare bills at the expense of non-essential services. To do this Congress will have to break from its recent tradition and recognize its Constitutional responsibilities. Our Constitution makes Congress responsible for taxation and spending.
Maintaining the current debt ceiling would likely cause a partial government shutdown. This would require our government pay for its actions out of cash flow rather than by borrowing additional money.
Upcoming bond auction likely to be managed within debt ceiling parameters
Many are concerned about U.S. bond offerings scheduled August 9, 10, and 11, for which our Treasury Department has planned to release the details on August 3. While many cite this as a cause for calamity, we are less worried. Should we limit the auction to simply refunding old debt, it should have no impact on the debt ceiling. We simply cannot borrow more than we retire. We expect that the interest rates we have to pay for this funding will be higher if there is not resolution.
Debt Downgrade 90% liklihood
After being on various watch lists since last April, rating agencies like Moody’s and S&P are threatening downgrade from AAA status. We would not be surprised if they did. One reason U.S. government debt received AAA ratings is that in the worst case the government could print money to service and repay its debt. However, if debt ceilings are enforced, our country will not be able to print money without borrowing.
Given current economic conditions – slow economy, low inflation – a downgrade implies a modest increase in the interest rates our nation pays. Over a longer term, should we again experience the “stagflation” of the late 1970s and early 1980s, a lower rating implies much higher rates and bigger problems.
This event would not likely change business conditions one way or another.
In the overall scheme of things, a ratings downgrade or partial shutdown are likely relatively minor. A debt default or full government shut down would bring more dire consequences.
Other nations, like the UK, have taken austerity measures. We can too. There is no need to go into default.
Debt default -- less than 10% chance
Should our elected officials remain unwilling to settle after a partial government shutdown, the next step would most likely be debt default. This would result in what we see as a very bad scenario.
We think the many people who believe we should let the nation go into default seriously underestimate the costs. Missing the debt ceiling alone does not mandate default. Defaulting would take a pro-active decision in Washington not to pay bills. Do you think our elected officials are capable of making that kind of decision?
We believe the risk of default in the near term is low. However, as bad as the fallout from the debt limit ceiling would be, a U.S. treasury default would be far worse. Do you recall what happened after Lehman Brothers failed? The international financial system nearly stopped. Short-term rates sharply increased. The commercial paper market shut down. Should we renege on our national obligations, the fallout from Lehman’s failure will look like a sideshow.
If this happens, expect a near complete and total financial meltdown. The world’s stock markets, bond markets, savings, and commercial banks all depend on governments to pay their bills. We are the largest borrower. At this point, no amount of quantitative easing or lower rates will help.
Complete government shutdown -- less than 2% chance
Should we default on our debt, and our elected officials continue in their currently untenable position, the next step would be for a complete government shut down. In this scenario business planning will not matter. We expect that chaos would ensue.
Action Item: Be prepared to provide additional management support and potentially changing the operating rules for major systems during any partial government shutdown.