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Debt Ceiling: What Happens If It Isn't Raised?

First Posted: 05/24/11 09:07 AM ET   Updated: 07/24/11 06:12 AM ET

Does all this talk of debt ceilings make your eyes glaze over? You know it has something to do with bonds and defaulting, but that's about it. You want to know what it all means and, perhaps more importantly, how this affects you.

The debt limit is the total amount of money the U.S. government is allowed to borrow to pay all of its existing bills, from paychecks for federal employees to interest payments on the national debt. On Monday, May 16, the U.S. hit the debt ceiling -- in other words, it borrowed all the money it is currently allowed to borrow. Treasury Secretary Timothy Geithner told Congress the government can continue to pay its debts until about August 2 by using "extraordinary measures," such as tapping into the pension funds of federal employees.

In the past, when the U.S. reached the debt ceiling, Congress voted to raise, extend or redefine the debt limit. Now the White House wants the debt limit raised again. Congressional Republicans mostly agree that the debt ceiling needs to be raised but have said they will not vote to do so unless it is accompanied by major spending cuts and long-term debt reduction.

So, for the sake of argument, let's say the debt ceiling isn't raised. The U.S. will then have to decide which expenses and debts to pay and which can wait. If the U.S. starts defaulting on (i.e. not paying) its debt, that's not just a problem for the entities that won't get paid -- it will affect the global marketplace and all of us who use it.

So far, the market doesn't believe the U.S. will actually fail to raise the debt limit. The evidence for this disbelief is everywhere: Interest rates are still low, there's high demand for U.S. debt, the stock market is stable, banks are lending to companies and to each other.

But what if the market's wrong? Here's a breakdown of what could happen if the debt ceiling isn't raised by August 2 -- and how it could affect you.

The Stock Market Takes A Dive
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If the U.S. starts defaulting on its debt, everybody who owns U.S. stocks and bonds will take a big hit. This will affect the big banks, corporations and even countries -- pushing some toward bankruptcy. That's the kind of slide that can spark a panic. On a more personal note, your 401(k) and/or pension will suffer big losses. It could take a long time to rebuild those funds, delaying retirement -- or making it impossible.
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