What is the Debt Ceiling Mellody Hobson

Mellody Hobson explains the debt ceiling in today’s “Money Mondays” segment.

Let’s start at the beginning. A common misperception is that the debt ceiling is the amount of money the government owes, and that raising the ceiling means increasing the federal debt. The federal debt is what it is…$16.76 trillion as of September 30th, according to the Treasury department. By contrast, the debt ceiling is the amount of money the government can borrow in order to pay that debt. That limit is currently $16.7 trillion, although technically the government already exceeded it in May. So the debt and the debt ceiling are different, but raising the amount the government is allowed to borrow will of course end up allowing the country to go deeper into debt, at least temporarily.

How is that money “borrowed” by the government and from whom are they borrowing?

You and me! And other people and countries all over the globe. Plus, in recent years, the Federal Reserve has emerged as a major buyer. The U.S. government borrows money by selling Treasury Bonds…and it uses the money it makes from selling those bonds to pay off existing debt and borrow additional money.

Should the government just cut federal spending?

That’s logical but could be disastrous right now because the economy is still recovering. According to the Congressional Research Service, cutting federal expenditures would mean discretionary spending would be drastically reduced—that includes defense, education and housing. Social Security would be threatened, taxes would need to rise and the economy would likely go into recession as a result. So a meaningful cut in spending is not a good option at this time.

That’s the day officials say the U.S. will run out of money. Defaulting on our debt would mean the government’s credit rating could be downgraded again and cause a default on U.S. Treasury bonds, which many Americans have as part of their retirement or investment portfolios. The dollar could crash. Not to mention, the low interest rates we’ve enjoyed for home-buying, credit cards or business loans would also rise very quickly. This debt issue has the potential to set our economy back into a tailspin. And not just us…Treasury bonds and the dollar are cornerstones of the global financial system, so it could affect the whole world if we don’t address it. It’s basically a financial doomsday scenario.

What do you think is going to happen?

I guess we’ll find out in a few days! But the debt ceiling is changed by Congress. They can either pass a standalone bill or include it in another piece of legislation as an amendment. Congress originally created the debt ceiling in 1917 during World War I in an effort to limit federal borrowing. Since 1960, the debt ceiling has been raised 78 times. It’s a simple matter of amending the law, but that means coming to a compromise in Congress.

And this is where the government shutdown comes in.

Exactly. There’s a standoff in Washington as Republicans and Democrats argue about the federal budget. Hopefully, they’ll at least come to a temporary agreement before Thursday.

Mellody Hobson is President of Ariel Investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts.  Additionally, she is a regular financial contributor and analyst for CBS News.