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US Debt Ceiling: What If No One Blinks?

Two Fighers in a DuelWe’ve been down this road before haven’t we? Almost three years ago, we wrote the following: “If Congress fails to raise the $14.29 trillion debt limit this spring, the United States government will default on its debt, a scenario that could throw financial markets into a state of unpredictable chaos… Treasury Secretary Geithner warned that a default would result in “catastrophic economic consequences that would last for decades.”

Déjà vu? Replace $14.29 trillion with $16.39 trillion and exchange Jack Lew for Tim Geithner – would it basically be the same article? Not quite – while back then, most pundits believed that early 2011 was the pinnacle of partisan bickering and brinksmanship (having come on the heels of the healthcare debate and mid-term elections in which the House changed hands), this time feels a bit different.

Markets and executives appear to be a bit more hesitant to take any action regarding a potential default. Perhaps it is in fact because corporate executives and investors alike are relying on the hope that cooler heads will prevail and a last-minute deal is once again at hand (see Debt Ceiling-2011 and Fiscal Cliff-2013).

Not so fast. In the midst of a government shutdown with no end in sight, the Speaker of the House looking over his shoulder desperately trying to keep his job, and a President who has finished his last campaign, the situation is nothing like it was two-plus years ago.

Too Little Too Late?

Perhaps Senate Democrats and Republicans will be able to forge a deal where House Republicans and the President could not. Maybe the pressure will eventually be too much for House leadership and they will have to allow a vote on a Senate-brokered deal, but it could still be too little, too late.

In 2011, S&P downgraded US Treasury debt to AA+ from AAA, citing the government’s dysfunction. Fitch Ratings warned this past June that if there is another prolonged battle to raise the debt ceiling, the ultimate outcome would not necessarily be the yardstick by which they assessed US debt; rather, the debate itself could lead to a downgrade. Fitch has cautioned: “Failure to raise the federal debt ceiling in a timely manner will prompt a formal review of the US sovereign ratings and likely lead to a downgrade.”

The Consequences

And if Congress deliberately does not raise the debt ceiling before we run out of cash to pay all our bills on time (which has never happened ), there would be no positive outcome. It is not clear what payments would be missed or how creditors would react. Such uncertainty could be the worst effect.

What would occur? Likely an increase in United States’ borrowing costs, with investors demanding more in exchange for their cash. This would in turn lead to an increase in mortgage rates, car loans–and corporate borrowing costs. The domino effects would be enormous as well. Equity markets would almost certainly fall, consumer confidence would crater, and companies would think twice before investing, hiring and expanding production.

Legislative Impact Analysis

An uncertainty this big can be seen from a long way off—and in a situation like this, where even the risk carries risks, such as a downgrade, it’s important to have a structured system for monitoring legislative trends. ERM teams can check that some type of screening framework is in place.

Here’s an example: One company uses a three-step process: evaluate, shape, and prepare. These components help them organize and use corporate resources effectively.

Evaluate: The organization developed a set of standard criteria to evaluate the likely impact of impending legislation. This is a relatively short-form exercise, replacing legislative memo writing with straightforward impact evaluations. The company spends the least amount of resources on this step, saving time and energy for later steps.

Shape: The company spends time educating government stakeholders on the economic implications of planned changes in the law. We have heard from members that this step can be difficult to manage. It may be cumbersome to establish a common language with government stakeholders to shape a productive conversation about legislative risks; thus, ‘moderate’ resources are spent in this area. The organization relies on standardization to ensure conversations have some consistency, but uses moderate customization for each legislative proposal.

Prepare: The final step is where the company spends most of its time, educating internal stakeholders on the implications of new legislation or a policy change, and on creating a clear response plan. Not surprisingly, it is a complex process to prepare both internal and external stakeholders for legislative developments and thus, the resource spend is high and the staff expends significant effort.

As you can see in the figure below, this company developed a standard set of criteria to govern the review and escalation of legislative change. They designate specific members of the team to review legislation or potential policy changes and scorecard it using this filter. This provides clear criteria to decide about resource allocation and change management.

The legislative responses are prioritized according to aggregate values in terms of likelihood of enactment, organizational impact, and department impact. However, other organizations could easily tailor the criteria to be used, including using the same criteria you use for your standard risk assessment process.
Legislative Impact Evaluation

Step-by-step, this company’s legislative impact evaluation includes:

  1. They first analyze two factors: the likelihood of (i) legislation enactment in the next 24 months and (ii) regulatory guidelines being published within 24 months. Both are scored on a 1 to 5 scale, with 1 meaning unlikely and 5 meaning already enacted or in place. Any legislation that receives a combined score of less than a 6 is passed over and not reviewed again for a year.
  2. The organizational impact is evaluated. They analyze the potential effect on enterprise growth, future revenue generation, and number of jurisdictions that will be impacted. A score less than 9 on this section is de-prioritized and instead managed as-needed at the local level.
  3. The department impact is scored. Alpha marks how many critical processes and special projects would be affected, and how difficult necessary modification would be. Legislative changes that score a value of greater than 7 trigger development of a detailed response strategy. Legislative changes that score a value equal to or less than 7 require development of a high-level response strategy.

Detailed Scenario Planning and Potential Default

After completing the other steps in their evaluation, the company uses scenario planning to develop detailed responses to the most critical legislative and regulatory issues (the US government potentially defaulting on their debt, certainly meets this criteria). The organization considers three cases; a best case, worst case, and most likely scenario.

Staff members identify the likely impact of the policy change and consider the cost-appropriate response to each scenario. Legislation is monitored on an ongoing basis through the use of triggers to signal when implementation of response plans are required. This avoids going to executive management with overly-complex legislative awareness and response plans from a multitude of scenarios. More detailed response procedures containing information on response owners, project execution start dates, and monitoring frequencies are distributed among staff.

The company said that these structured analysis, education and response planning activities have strengthened the company’s legislative posture and enabled a more effective, less resource-intensive response to legislative changes.

CEB Risk Management members should the full case study on this Legislative Impact Analysis and review our most recent Public Policy and Regulatory Risk Update.

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