5 Reasons the Market Wants the Debt Ceiling Raised

The market has spoken: it wants Congress to raise the debt ceiling. This might not have been clear before, as it's often hard to know precisely what the market is thinking. When Standard and Poor's revised its U.S. debt outlook, for example, the market had a mixed reaction. But now, it has provided the clearest indication that it possibly can that it believes a failure to raise the debt ceiling would have terrible consequences. It has formally urged Washington to take this action through its chief lobbyist, the Securities Industry and Financial Markets Association (SIFMA).

SIFMA's statement is written by one of its members, JP Morgan Managing Director Matthew E. Zames. He serves as the chairman of SIFMA's Treasury Borrowing Advisory Committee. The letter makes crystal clear that not raising the debt ceiling isn't an option in the eyes of the global market. Very, very bad things would happen if Washington lets politics stand in the way of practicality. Zames provides five specifics:

1. Foreign Investors Dump Treasuries

Foreign investors could permanently reduce their Treasury holdings, as they would no longer trust American policymakers to make good on the nation's debt. Zames says this would drive up Treasury yields, costing taxpayers $75 billion more per year for every 0.5% increase in Treasury interest rates. Also, see my colleague Megan McArdle's post from earlier this week about how bad it would be for the U.S. if China cut its Treasury holdings.

2. U.S. Debt Downgrade

SIFMA also worries that a default or even a delay in raising the ceiling could lead to a sovereign debt downgrade by the rating agencies. Zames estimates that for each one-notch rating downgrade, Treasury interest rates would rise by 1%. Using the numbers above, that's $150 billion per year more for taxpayers.

3. Money Market Funds "Break the Buck"

A financial crisis would likely occur if the U.S. defaults. Zames says that this could cause a run on money market funds, like we saw in 2008. Treasury Secretary Geithner warned of this possibility in his recent letter to Congress on the debt ceiling.

4. Another Credit Crunch

Higher Treasury interest rates would increase borrowing costs. Since Treasuries are often used as collateral, this would cause lenders to demand more cash or other collateral from borrowers to cushion potential losses. Credit would shrink, because borrowers could not afford as much.

5. A Double Dip

Less borrowing might sound like a good thing, but this means firms will also have to cut plans for growth and investment, which could hamper the recovery. For growth to continue on its slow but steady path, business have to keep spending.

Zames also notes that even if a technical default doesn't occur, if the Treasury must resort to extraordinary measures due to a prolonged debt ceiling debate, then the market could still respond with negative reaction. So the threats here aren't quite as outlandish as a U.S. default might be. If policymakers take their time raising the ceiling, some proactive investors could worry about enhanced uncertainty due to higher-than-anticipated political risk.

What's odd, however, is that SIFMA addresses its letter to Geithner -- not Congress. This is a strange choice, because Geithner has no power to raise the debt ceiling. Indeed, he has already urged Congress to take action immediately. Perhaps SIFMA would be better served to send the letter to high ranking members of Congress, like House Speaker John Boehner (R-OH).