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Dancing on the (debt) ceiling: Will card rates really rise without a deal?

Jeremy Simon

A warning to credit card holders: The U.S. government’s borrowing problems could soon become your borrowing problems.

Right now, in Washington, politicians are fighting over whether to raise the U.S. debt ceiling — which determines the amount of money that the nation can spend on its debt — above $14.3 trillion. If the debt ceiling isn’t increased, the United States won’t have enough money to pay all of its bills. That could result in a default on its financial obligations. A default could drive rating agencies (which assign a measurement of risk to debt issuers including the U.S. government, much like FICO does for consumers) to decide that the U.S. government bonds have become more risky, resulting in ratings downgrades for U.S. debt, also known as Treasuries.

In the President’s view, default would be a disaster. “For the first time in history, our country’s triple-A credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet,” President Barack Obama said in a televised prime-time speech. “Interest rates would skyrocket on credit cards, on mortgages and on car loans, which amounts to a huge tax hike on the American people.”

When it comes to credit cards, “skyrocket” may be too strong a word. That’s because experts say there isn’t a direct or immediate relationship between exceeding the debt ceiling and higher annual percentage rates (APRs) on your credit card. Still, they agree that the economic fallout and resulting downgrade would trigger a chain of events that could boost card rates.

Washington needs to work fast. We actually already hit the debt ceiling back in May, but the Treasury Department has been shuffling money around and delaying payments that it could, which bought us a few months. That time runs out Aug. 2. In case you haven’t checked your calendar lately, that means a decision needs to happen by Tuesday.

What happens if the government oversteps the debt ceiling? “It’s like a consumer who goes over their credit limit and the bank has the ability to decide if they get a credit line increase or not,” says Dennis Moroney, research director in the bank cards division with advisory services firm TowerGroup. In this case, the U.S. government would then appear much riskier to investors.

Regardless of whether the debt ceiling is raised by Aug. 2, some experts say that because the rating agencies know there’s a serious problem, they could issue a downgrade anyway. “Standard & Poor’s has made it clear that barring a long-term solution to the problem of government rising debt, it would downgrade the U.S. credit rating below AAA,” says Greg Daco, senior economist with IHS Global Insight.

Tony Plath, a professor of finance at the University of North Carolina at Charlotte, warns that a “downgrade will ripple through financial markets, triggering higher interest rates on long-term Treasuries and steepening the yield curve,” he says. A steepening yield curve is one in which the spread is increasing between the yields of short-term and long-term Treasurys.

Banks are then likely to follow suit by raising rates. “This occurs because many variable-rate bank loan agreements are priced using a Treasury bond benchmark; or because as Treasury rates rise, the general level of market interest rates can be expected to rise as well, increasing bank funding costs,” Plath says in an email.

Additionally, as the U.S. government’s borrowing costs increase, it could in turn increase the rates it charges banks, in an effort to make up for any shortfalls. Banks, typically, “would pass that along to the consumer,” Moroney says. That could mean higher credit card APRs. (However, that would only impact borrowers who revolve a balance from month to month, and thanks to the Credit CARD Act of 2009, would only increase APRs on card debts incurred going forward.)

Just how quickly could APRs rise? “Given the ultra low level of market rates and the pressure on banks to boost profits, any increase in Treasury rates will be followed in lockstep with increasing consumer rates within 90 days or so,” Plath says.

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  • Brian

    Big deal. If APR rates were increased to 100% on auto-loans and credit-cards, I could care less. If you’re financially responsible then interest rates should be the least of your worries. Pay your card in full at the end of the month, buy a car you can afford to pay off at once, get a fixed-rate mortgage, live well within your means and finances will be a breeze. I spend an average of $5,000 a month on my credit-card that I pay off a week before the statement is posted (small business expenses), I drive a old ’98 Corolla that I paid off in cash, and I have a small house that I also paid off in cash. No money worries on this end.

  • M

    Congratulations Brian. Hope you’re thankful that you don’t have exorbitant medical expenses that aren’t covered by insurance.