The writing has been on the wall for months so some may find the urge to gloat over Rep. Kevin McCarthy’s ill-fated House speakership to be irresistible.
The simple fact however is his ouster could cost everyone as a dysfunctional legislature, stewards of the nation’s purse strings, may drive already high borrowing costs even further into painful territory for the average American.
Last month Moody’s already flagged that it might follow rivals like S&P Global Ratings in withdrawing its gold standard AAA rating for U.S. federal debt if the government shuts down. And the latest Beltway drama also highlights a stern August warning by Fitch over the political class’s inability to act in the collective interest of the country.
McCarthy’s ouster after fewer than nine months on the job comes at a critical juncture for the economy. Pandemic era savings for most Americans have been exhausted, payments on nearly $2 trillion in federal student debt have resumed and energy prices are surging amid cuts to oil production.
A potential Moody’s downgrade is only the cusp of the problem. Whether it is a 30-year fixed rate mortgage or a 72-month loan on a new vehicle, all debt is priced off benchmark U.S. sovereign bonds, whose creditworthiness—measured in their yield—forms the basis of the risk-free rate.
If bondholders begin demanding 5% to lend money for 10 years to a government, knowing full well it possesses both its own printing press and the power to tax, they will expect far more from U.S. commercial banks that don’t.
“Investors are sick and tired of being jerked around with out-of-control spending, the inability to govern and the constant dragging of markets to the edge of economic calamity with shutdowns and debt ceiling nonsense,” Harris Financial Group managing partner Jamie Cox told MarketWatch.
Banks then turn around and pass those higher costs on to their customers in the form of steeper loan rates. Everyone from small, family-run businesses to homeowners and car buyers will feel the pain for a loss of confidence in the government’s ability to function.
Borrowing costs for government at 16-year high
The fixed income market is already reeling from a six-month old debt ceiling crisis that depleted the U.S. Treasury’s reserves. Replenishing its coffer has meant flooding the system with new paper to raise fresh capital for running the government.
Not only has this driven federal debt past the $33 trillion mark, but investors already stuffed to the gills with government bonds want higher compensation for each incremental dollar they lend. This is why yields on benchmark Treasurys have risen to 4.8%, a 16-year high.
“The worry is that the escalating federal budget deficit will create more supply of bonds than demand can meet, requiring higher yields to clear the market,” veteran economist Ed Yardeni warned on Tuesday.
Latest projections from the Congressional Budget Office in June suggest the government will have to spend 2.5% of GDP to service its debt this year, a full tenth of a percent higher than in its February forecast.
Not only does this impose a future liability on taxpayers, but in a credit crunch, investors will inevitably lend to the government first and Main Street second.
A weak House speaker from the beginning
The worst part of McCarthy going down in history as the shortest-serving House speaker is its predictability.
His campaign to replace Nancy Pelosi required 15 ballots—more than any other predecessor since the Civil War. Rather than bow out, however, the Republican congressman from California cut so many deals in a bid to seize the nation’s third highest office, he had zero wiggle room for rebellion given his razor-thin majority.
Already then it was clear his power would rest solely in the hands of a small group of ideological Trump loyalists like Florida Rep. Matt Gaetz, who could at any time put a vote to the House floor for his removal.
“When we stand here a week from now, I won’t own Kevin McCarthy anymore, he won’t belong to me,” Gaetz said on Monday.
Ironically the rebel leader justified withdrawing his confidence this week by warning of the risk to Americans should countries worried by the national debt collectively abandon the dollar.
By unleashing further drama on the American people tired of a dysfunctional Beltway, he may in fact be causing at least short term pain on the very individuals whose interests he claims to protect.
“It’s not how you start, it’s how you finish,” McCarthy said in January after his election. Those words, which in retrorspect proved inadvertently prescient, may now cost everyone in the end.