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Debt Ceiling deal : What does it mean to me?

Unless you have been living under the rock, you would have heard all the back & forth around the debt ceiling crisis. After a few weeks of fierce drama on the political stage, President Obama signed the debt ceiling deal aka Budget Control Act Amendment (the link is to the actual bill which is 74 pg. long) today. But what does it mean to me – an average Jane? Immediate effects – nothing (except student loans, read below), we have not defaulted and Government will have money to pay for its spending. But the after math of the deal will be interesting. There are several things on the line that could affect all of us.

What is the debt ceiling crisis?

Wikipedia explains it much better than I can. But here is the Cliff Notes version – We spend more than we earn. If the treasury doesn’t have enough revenue to pay for the federal spending, they can issue debt (debt held by the public or Intra-Governmental holdings) to pay for the deficit. And there is a ceiling on how much can be borrowed, that is the debt ceiling. We were always in debt, but the recent economy crisis has resulted in more programs (tax cuts, unemployment increase, bailing out the banks) that we increased our debt even more. So when the time came around to increasing the debt ceiling, the battle about how to cut spending started between the two parties. Unless that was resolved the bill to increase the debt ceiling could not be signed. After much gnashing of teeth, a compromise was reached on Sunday July 31st. And the bill was signed by Mr. President today.

Summary of the debt ceiling deal

  • Cut spending by more than the increase in the debt limit. In the first phase, $917 billion would be cut over 10 years in exchange for increasing the debt ceiling by $900 billion.
  • Pell grant funding was increased by $17 billion.
  • Cuts to graduate student loans.
  • Establishes a joint committee of Congress to reduce the spending by November 23, 2011. The goals of this committee would be to cut at least $1.5 trillion in deficit over the next 10 years and get the legislation passed by December 23, 2011. This committee will have 6 members from each party. The NYT has a great infographic on how the debt plan works if you are interested.
  • If Congress fails to produce a deficit reduction bill, Congress would increase the debt ceiling by $1.2 trillion by trigerring across the board cuts. There are a few exemptions to this across the board cuts – Social security, Medicaid, military employee pay to name a few.
  • The debt ceiling may be increased an additional $1.5 trillion if either one of the following two conditions are met:
  • A balanced budget amendment is sent to the states
  • The joint committee cuts spending by a greater amount than the requested debt ceiling increase.

So how does this translate to our bottom line now?

Debt ceiling and student loans

There are two sections in the debt ceiling deal that will directly affect the graduate and professionals students (undergraduate students are not affected).

  • Termination of interest subsidized federal loan : These loans don’t charge students any interest on the principal of the student loans until six months after the student’s graduation. Now graduate students will start accruing the interest rate payments while they are in school. They don’t have to make payments on the interest or the principal until after they graduate, but the interest will accrue regardless. They can choose to pay the interest while they are in school though. This measure will go into effect on or after July 1, 2012.
  • Termination of direct loan repayment incentives : The special credit for all students who make 12 months of on-time loan payments will be scrapped.

Pell grants are still there and got a $17 billion raise which would protect the program from cuts until 2013. But as the program itself is in a deficit, it might suffer some cuts in the future in 2013.

Debt ceiling deal and retirement planning

Here are some lessons from the debt ceiling crisis related to retirement planning.

  • We should be diversifying well with international holdings.
  • We can’t rely on Social Security and Medicare during our golden years (esp. young folks). Save for your own retirement and health care. Medicare is in immediate danger in fact. If the joint committee mentioned above cannot come up with a deficit reduction legislation, Medicare is on the line with the across-the-board cuts.
  • With the deficit reduction, there will be cuts to state and local Government aid, which mean muni bonds won’t be reliable. Particularly the muni bonds from states that already have very weak budgets. Instead, essential bonds might be a better idea.
  • Payroll cuts are not extended. This is not related to retirement planning per se. But hopefully people are channeling the payroll cut to their retirement accounts, so from 2012, you cannot rely on this extra funding. Go over you budget and start saving more for retirement. Do a retirement number calculation ignoring social security payments. Experts say SS will be there, but I am sure we won’t get the full amount anyway.

Debt ceiling and health care

Health care is not immediately affected as of now. But as I mentioned before, if the special committee cannot come up with a plan by Thanksgiving, we are looking at a cut in Medicare payments. This could be a direct cut to the payments, for example 2% cut or they may raise the eligibility age or it could mean an increase in copayments. However it is done, the cuts will be real and this could mean hospitals dropping Medicare patients.

Other

They say that the interest rate for bonds would increase (as the rating agencies will now rate US treasuries as risky investments) which would translate to an increase in consumer loan interest – credit card and mortgage rates.

But to see the full effect, we will have to wait and see where this takes us and whether the joint committee can bring about legislation.

{ 14 comments… read them below or add one }

cashflowmantra

I don’t plan on Social Security or Medicare really being there for me in 25 years when I would be needing it anyway so any changes there will have little impact. I would like to see Washington focus on jobs now whether that is creating jobs or offering some incentive for all the profitable companies to begin hiring again. We need a virtuous cycle to start.

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The Biz of Life

As with most budget deals, it mainly consists of budget gimmickry, or accounting on crack as some people like to say. There is not one penny of real cuts in the entire thing, no elimination of ineffective or duplicate programs, only minor reductions in the growth rate of spending. The only certainty in the deal is that it grants the politicians the right to run up the debt by an additional $2.4 trillion. Be sure to thank your representatives appropriately every opportunity you get.

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The Biz of Life

Some additional info. Best case, this deal guarantees an addition $7 trillion in debt over the next 10 years. Worse case, who knows how high it could go.

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Paula @ AffordAnything.org

Wow, this is a great summary. I did a little summary on my site today, but yours paints a much more clear picture of the compromise and its consequences … mine was basically a rant that people should end the partisan bickering :-) I think its crazy how much the stock market has fallen in the past week due to the debt ceiling debate!

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Suba

Thanks, Paula. Yes, we finally moved money from some company stocks we sold last year and bought into some new companies. Let see how that goes.

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retirebyforty

Great summary! I agree that we need to cut spending, but the government needs to bring in more revenue as well. This means either more tax payers or more tax. Nothing is free, we have to figure out how to get out of this debt spiral.

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Suba

Yeah, classic earn more, spend less concept, but as always we want to fix this without affecting us :)

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Financial Samurai

The student loans and state debt issues could be a very big issue.

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Suba

Yeah, states like CA is already super weak…

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mbhunter

Oh … I thought it was just a big distraction so that they could push through a lot of other stuff without a whole lot of public debate. :)

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101 Centavos

“The goals of this committee would be to cut at least $1.5 trillion in deficit over the next 10 years and get the legislation passed by December 23, 2011.”
And yet, the budget deficit is well in excess of $1 Trillion each and every year (!!). I don’t know what this says about the nation, that these legislators can talk about this with a straight face and not get called on it.
We’ll be seeing this issue rear its head again next year, or perhaps sooner, if states start defaulting on their own obligations.
Nice recap, Suba.

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Bret @ Hope to Prosper

This is a great summary Suba.

I do believe the rates on treasuries will have to go up, which will only help to increase the deficit. The government has been getting away with yields that are below the true rate of inflation for many years and propping up bond sales with QE2. Now that treasuries are technically riskier, I beleive a lot of investors are taking a hard look at alternatives.

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MoneyCone

A very good explanation on debt ceiling Suba! Well done!

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whosebone

I can’t recall how many “Professional Politicians” have gotten in front of a microphone to tell us that “raising the debt ceiling does not increase spending, it is simply to pay off the debts we already incurred.” How in the hell do you think those debts got there, by the tooth fairy, this tells you how stupid they think the public is. They think if they can say it loud enough and over and over we will soon believe their trash, I’m not falling for it. You incur debt when you spend too much, plain and simple, the reason they have to keep raising the debt ceiling is that they are incurring too much debt.

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