10/02/2013 01:21 pm ET Updated Oct 02, 2013

Debt Ceiling Worries Wall Street Amid Government Shutdown

WASHINGTON -- Wall Street is growing more skittish about the prospect of the U.S. defaulting on its debt now that an indefinite government shutdown has resulted from GOP House members' refusal to fund the government without hamstringing President Barack Obama's health care reform law.

"So far, there are no signs of heavy political damage so the chances of Washington going beyond October 17 without a debt ceiling agreement continue to rise," Keefe Bruyette & Woods analyst Brian Gardner wrote in an Oct. 1 note to clients. "We now think the chances of this occurring are 40% (up from 15-20% last week)."

Treasury Secretary Jack Lew wrote a letter to House Speaker John Boehner (R-Ohio) on Tuesday saying that the government will be unable to avoid defaulting on its debt if Congress does not raise the debt ceiling by Oct. 17.

"There are no other legal and prudent options to extend the nation's borrowing authority," Lew wrote.

Several experts have warned that a U.S. default, however brief, could trigger a financial crisis akin to what happened after Lehman Brothers filed for bankruptcy in 2008.

The government shutdown has dealt a modest blow to the economy by furloughing federal workers, shutting down government-funded research and closing National Parks, hurting businesses dependent on those operations.

But a default on U.S. government debt would likely trigger significant turmoil in the financial markets. U.S. debt is generally considered among the safest of all financial assets, with many metrics treating it as risk-free.

The cost of purchasing insurance against a default on U.S. Treasury bonds has increased dramatically over the past two weeks, according to data from Markit, a financial information company. Higher insurance prices indicate greater investor fears that the government will default. From mid-July through most of September, the cost of insuring a one-year Treasury bond against default was no higher than 0.06 percent of the value of the bond, according to Markit's credit default swap data. But since Sept. 23, that price has quintupled to 0.30 percent.

Stock prices have also slipped, with the Dow Jones Industrial Average falling about 550 points (about 3.7 percent) since mid-September.

Nevertheless, Gardner believes the market reaction would be significantly more drastic if investors believe the administration's warning that it will in fact default on Oct. 17.

"It seems that investors think that Treasury can prioritize payments so that no bond payment would be missed. Administration officials continue to push back against this view but for now, we think it restrains volatility," Gardner wrote. "Despite the current market view, we expect volatility will increase as we get closer to October 17th."

Raising the debt ceiling does not authorize the government to spend more money, but allows the government to borrow the money necessary to pay for the spending Congress has already authorized.


2013 Government Shutdown
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