Debt Ceiling: What is it?

Have you ever owned a credit card? They usually give you a credit limit, right? Well, say your credit limit is $1000. We would state that your debt allowance (or leverage) is $1000 for that “one-leg” of debt based upon your financial situation. Now, imagine you go in for a mortgage loan, and a bank gives you $100,000. Perhaps, you also have a few student loans that total $10,000, and you have a car loan that’s $5,000. With all of these “legs” of debt existing independently, it’s difficult to assess the overall “stress” of your current financial situation. That’s why you have a credit score…or the ability for outside institutions as well as yourself, to somehow measure your overall credit-worthiness.

In this same way, banks, financial institutions, corporations and, yes, even the US government has a credit agency rating its “bonds” (or overall credit-worthiness). However, unlike your personal situation, the US government has bonds broken down into countless different “legs”, both temporally (short-term vs long-term), riskiness, and other categories (such as state loans, etc). Because of the many different legs and levels that exist, it’s highly difficult to assess the overall leverage that the US government has, and how easily it would be able to pay it off. In addition, the approval process for these different avenues of lending would be highly difficult for getting things done in a timely manner since Congress has to approve any major bond issuances, etc. So, in 1917 under the Second Liberty Bond Act, a statutory “total” amount of debt was instantiated on the U.S. Treasury, and enforced by Congress. This imposed “limit”, although not known at the time, allowed for more freedom in 3 ways: (1) the U.S. Treasury to extend debt for any public operations; (2) credit rating agencies to more easily evaluate the overall leveraged position situation of the U.S. government (3) Congress to have the ability to adjust the allowable debt (the debt ceiling) based upon necessity in a timely manner.

So, the next time you think about the debt ceiling, just think about your own financial situation, and understand that just as you have a total debt allowed for your net income, so does the US government. Now, if only we could convince a few banks or our local government to be able to continually raise our debt ceiling every time that we need a little extra “cha-ching” for a Vegas trip or a bigger house…

Stay Tuned for the next segment of this…

This entry was posted in Gibberish. Bookmark the permalink.

Leave a reply