Risk & Economy » Disruption » Part 2: The debt ceiling debate will impact all CFOs – it’s high time they prepare

Part 2: The debt ceiling debate will impact all CFOs - it's high time they prepare

While a US government default might seem unlikely, the increasing national debt makes it ever more possible. CFOs should plan for the worst case

Part 2: The debt ceiling debate will impact all CFOs – it’s high time they prepare

To read part 1 of this article series, click here

CFOs have an increasingly complex role. Not only are they champions of business transformation, but also required to stay vigilant against ever-increasing global economic challenges.

However, what happens when the economic threat is your own government?

In early 2023, the US Treasury declared it would default on its payments within six months if Congress did not vote to increase the country’s debt ceiling. While a suspension was agreed, perilously close to the buzzer, the situation sent serious ripples through the US economy.

“We’ve got an 18-month reprisal here … but it’s going to come back and it’s going to come back heavier”, says Michael Eitler, COO, and former CFO for Exploring and McCracken Alliance.

“We are running out of time. We’re years, not decades, away from having serious consequences”, says Eitler, referencing analysis from the Congressional Budget Office (CBO) that suggests interest payments will become the US Government’s third largest expenditure by 2028.

“That’s going to be quite contentious and unsettling for the world. Because … the world is connected, and what happens in the US economy is very impactful around the world,” he says.

The default scenario

It has been less than two years since the debt ceiling was last discussed in Congress under President Trump; it may be discussed again when the suspension ends in early 2025.

It appears incidences of this debate are becoming more frequent, meaning CFOs should be preparing for a default scenario. While it may be the worst case, it’s not impossible.

“A default would be felt broadly across the economy,” says David Trick, CFO for Ambac Financial Group. “It would impact individuals who rely on government payments […] to live, financial institutions, the banking system, and the capital markets”,

Trick says a default would necessitate a downgrade of the US by the credit rating agencies, raising the ultimate cost of government borrowing and capital across the US economy. “It would also call into question the value of any USD-based asse [and] would likely tip the economy into recession,” he adds.

In 2023, the mere mention of default caused disruption, with Fitch Ratings downgrading the US to double-A, and interest rate increases on treasury bonds.

“The longer a default persisted, the more challenging and time-consuming it would be to repair … a default, longer-term, would certainly call into question [USD] as the global reserve currency and likely lead to capital flight from the US”, says Trick.

As we skate closer to a potential default, which as the debt rises becomes more likely, financial markets have gone on the defensive.

“The first downgrade immediately sent shockwaves through the equity markets, and it impacts currencies, exchange rates, availability to liquidity and all those things. So, it’s a pretty big deal”, adds Eitler.

Steve Griffin, CEO of Madison Avenue Technology says a US government default would have severe consequences for the global economy.

Griffin, who acts as an outsourced CFO through his own tax and accounting firm, says that while CFOs can take proactive measures to prepare for such an event, “it is in the best interest of all parties involved to work towards a resolution that ensures financial stability and the integrity of the global financial system.”

CFO strategy for guarding against the worst case

For CFOs to ensure resilience through a potential default scenario their strategy should focus on six main components.

Firstly, “CFOs should conduct a comprehensive risk assessment to understand the potential impact of a government default on their organisation’s financial health”, says Griffin.

“[It] should encompass factors such as exposure to government bonds, the nature of existing contracts, and the financial stability of key business partners.”

Scenario planning is essential for riding out economic hardships. Most financial models might plan for a 5-10% decrease in assets, even up to 25% if especially pessimistic. However, Michael Eitler suggests this might not be enough.

“[Before the 2008 crash] we ran [models] all the way down to 50%,” he explains. “Nobody can imagine that in a very short period of time the overall value of a company could shrink to that degree, but they did.”

One of the greatest risks of a government default is that it would trigger a recession, meaning liquidity management is paramount.

“Things are going to cost a lot more [and] the cost of borrowing money is going to be extremely high. CFOs, and quite honestly, all the executive team now preserve cash. Cash is always King”, explains Eitler.

“CFOs should also collaborate with banks and financial institutions to explore alternative funding sources that can sustain operations during turbulent periods”, adds Griffin.

Trick says preparing goes hand in hand with good long-term planning and financial discipline. “[Businesses must] avoid being over-leveraged, diversify their sources of capital and liquidity, diversify supply chains, and instill budgetary and balance sheet discipline,” he says.

This requires spreading out investment portfolios and adopting hedging strategies, reducing the concentration risk associated with government bonds and mitigating potential losses in the event of a default.

When it comes to economic uncertainty, remaining transparent across the business is a must.

“CFOs should proactively engage with key stakeholders to convey the organization’s preparedness and contingency plans. Timely and honest communication helps build trust and minimizes any potential panic or misunderstandings”, explains Griffin.

And more than ever, CFOs must keep informed on legislative and regulatory developments related to the debt ceiling payment obligations.

“By staying informed about potential policy changes and engaging with industry associations, CFOs can better assess the evolving landscape and adapt their strategies accordingly”, says Griffin.

Reducing the debt requires political unity

However, it is troubling that the US debt ceiling debate continues to be brought before Congress, and indicates a lack of proper governance, from leaders whose interests appear to be more about election results than effective leadership.

“[The] debt ceiling has increasingly become a political tool”, says Trick. “The lack of unity and bipartisanship let the opportunity to implement stronger budgetary discipline and spending reductions pass us by.”

“Real fiscal discipline could make the Fed’s job of tackling inflation easier, and put the US on longer-term stable footing, especially since current fiscal and monetary policy is at odds.”

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