HOT TOPIC: The Government Shutdown

What Can We Learn from the Government Shutdown?

Late in the night on October 16, Congress ended a 16-day government shutdown and prevented a potential default of federal financial obligations by passing the Continuing Appropriations Act, 2014. President Obama signed the bill just after midnight on October 17, and the federal government was back in business — for now.

In fact, nothing fundamental was settled, and lawmakers must revisit complex and contentious issues in early 2014. Now that the government has reopened its doors, this may be a good time to consider the damage that was done and what the crisis might reveal about the economy and prospects for future negotiations.

Fiscal Friction
The crisis was a combination of two fiscal deadlines that merged into a single impasse. It started with a conflict over funding the federal government for fiscal year 2014, which began on October 1, 2013. Without funding, many government agencies were forced to close or cut back on services. About 800,000 federal employees were furloughed, and the public lost access to a wide variety of services.1

The situation escalated as the calendar approached October 17, which was the day the Treasury expected to reach the statutory limit on government borrowing (often called the debt ceiling) and would be unable to meet all federal financial obligations. The Act funds government operations at current spending levels through January 15, 2014, and suspends the debt ceiling through February 7.2–3

An Economic Setback
Financial ratings agency Standard & Poor’s estimates that the shutdown cost the U.S. economy $24 billion — enough to reduce projected fourth-quarter growth of gross domestic product from 3.0% to 2.4%.4

This figure includes about $3.1 billion in lost government services. Although federal employees will receive back pay, their missed workdays created backlogs in services ranging from processing small-business loans to analyzing and releasing economic data.5–6

The closing of National Parks cost some $76 million per day, including the impact on nearby communities. Spending losses for the travel industry are estimated at $152 million per day, with Washington, D.C., hit especially hard.7 In the midst of the crisis, consumer confidence experienced its sharpest one-week drop since 2008.8

The Stock Market Shrugged
Despite the shutdown and uncertainty over the debt ceiling, the stock market remained surprisingly steady throughout the crisis.9 After the deal, the S&P 500 index closed at a historic high on October 17 and set another record the next day.10

This suggests that investors didn’t seriously believe the possibility of a default. It may also indicate that the market places more emphasis on business earnings than on political maneuvering and anticipates continued monetary support from the Federal Reserve.11–12

The Treasury and the Fed
The Treasury had been using emergency measures since May to keep the debt from rising above $16.7 trillion. When the ceiling was increased, it quickly moved to rebalance its books and fund pensions and other programs that had gone unfunded, sending U.S. debt to a record $17.076 trillion.13 Despite this staggering load, the debt has become less expensive for the government to maintain over the last five years, due in part to low interest rates driven by the Federal Reserve’s stimulus efforts.14

While Congress remained at an impasse, the yield on short-term and longer-term Treasury bills rose, but quickly eased back after the crisis was averted.15 Because U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest, the prospect of default led investors to demand higher rates — a glimpse of the potential disruption if fundamental fiscal issues are not resolved. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid.

The economic jolt of the crisis and the uncertainty of future negotiations may lead the Fed to delay easing back on stimulus efforts until 2014.16 Even if the Fed does act sooner, it’s unlikely that rates would rise significantly, given continuing economic concerns and the increased costs of government borrowing at higher rates.17

What’s Next?
For investors, the relatively mild market reaction to the crisis may help boost confidence in maintaining an appropriate investment strategy without overreacting to politics. However, it might be wise to keep an eye on future negotiations and hope that lawmakers will find common ground in a more timely fashion.

The S&P 500 is an unmanaged group of securities that is considered to be representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

1, 3, 6) The Wall Street Journal, October 17, 2013
2) CNN.com, October 17, 2013
4–5, 7) Time.com, October 17, 2013
8) CNNMoney, October 10, 2013
9, 11, 15) The Wall Street Journal, October 19, 2013
10, 12, 16) Bloomberg, October 18, 2013
13) The Wall Street Journal, October 18, 2013
14) Pew Research Center, October 9, 2013
17) Forbes.com, September 17, 2013