U.S. Default

The disagreement between Republicans and Democrats over the U.S. budget, debt ceiling, and Obamacare has led to the first government shutdown since 1995. Millions of federal workers have been furloughed until an agreement can be reached (although salary for missed time will be reimbursed), however the primary concern for many Americans is whether or not the U.S. government will default on its obligations come October 17th. This is the expected deadline for raising the debt limit based upon tax revenue and accumulated debt. Based upon negotiations during the fiscal cliff in 2012 and the 2011 debt ceiling disagreement, it appears that a deal will most likely be accepted in the 11th hour, however it is important to understand the ramifications if the U.S. were to default on its financial obligations.

One of the primary fears for U.S. Treasury bondholders is that they will not receive their specified interest payment on October 31. Just like corporations, if the U.S. were to default on its financial obligations, investors would seek higher interest rates in order to offset the potential of a credit default. In addition, an investor led run away from U.S. Treasury bills and a potential sell-off could drive interest rates even higher and unravel domestic finances. If the United States needs to pay-out higher interest rates without any spending cuts, it will only drive the national debt up further.

On the equity side, a credit default can have a major impact on consumer confidence similar to 2011 and negatively affect stock prices.  During debt ceiling negotiations in 2011, the global equity market lost nearly $6 trillion in value. It is a fair assumption, given that the U.S. did not default in 2011, that a failure to reach a budgetary agreement will have an even greater impact on the markets this year.

During a time of high market volatility and political uncertainty, it is imperative to fall back upon your financial plan in order to ensure that decisions in your portfolio are not made on emotion. If you do not have a financial plan, please contact Mitlin Financial for assistance.

Disclaimer: This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.