Why There's Now One Less Worry for Markets

SMITH BRAIN TRUST – There was a key development on Capitol Hill last week you might have missed.

With headlines dominated by the partial government shutdown and Apple’s downwardly revised sales forecasts, the decades-old Gephardt Rule, which seeks to avoid having the U.S. run afoul of the debt limit, was given new life.

For financial markets, this quiet development is pretty big news, says Phillip Swagel, a senior fellow at the University of Maryland Robert H. Smith School of Business Center for Financial Policy and a professor of international economic policy at UMD's School of Public Policy.

By averting the need for members of Congress to cast a politically unpalatable vote to raise the debt ceiling, the move could help the federal government avoid another funding disruption this spring. And given the recent spate of volatility buffeting the markets, that’s likely some relief, he says.

The Gephardt Rule, crafted by former House Majority Leader Richard A. Gephardt and first applied in 1980, automatically raises the debt ceiling when the House and Senate jointly approve a budget resolution that exceeds the previous limit. It’s been applied 20 times since 1980. “It meant, essentially, that a difficult vote was subsumed into a less-difficult vote,” Swagel explains.

Under a rules package approved last week by the new Democratic-led House of Representatives, the proposal to raise the debt ceiling would be deemed to be approved and sent over to the Senate with only a vote on a budget framework but not a separate House vote on raising the debt limit itself. The Senate would still need to approve the higher debt ceiling, but this has been a lesser obstacle in recent years.

While this looks like a minor procedural change, Swagel says that the House’s new rules may serve to eliminate substantial risks to the global financial markets that would arise from a default on Treasury securities. And they come at a time of particular division in Washington.

“Look at what’s happening now with the partial government shutdown,” he says. “That is a dispute over the details of government spending – on spending roughly $5 billion on border security. The Gephardt Rule helps avoid having the debt ceiling caught up in these thorny issues.”

Last February when it approved the Budget Act of 2018, Congress suspended the debt limit, which sets a ceiling on the amount of outstanding debt that the U.S. Treasury is allowed to carry. But when that suspension expires on March 1, the Treasury will again be forced to resort to cash management maneuvers to avoid running up against the debt limit, since it will be limited in its ability to issue new bonds are a key source of government funding, along with tax revenue.

“My sense is that all of this is a symptom of our divided government, which is a symptom of our divided society. I could imagine better ways to do things. Once Congress agrees on a spending framework, it seems like that’s tantamount to deciding to borrow to fund the spending.”

The new semester at the University of Maryland begins in about two weeks. Swagel will be teaching an undergraduate course on American Economic Policy and discussing fiscal policy, beginning in the third or fourth week.

“I hope that both the partial shutdown and the debt ceiling are resolved by then,” he says. “If not, we’ll be talking about them. Quite a bit.”