Small investors worry about debt-ceiling impasse

While politicians in Washington refuse to compromise on raising the debt ceiling, small investors are worrying about what a stalemate might mean to their life savings.

Financial planners say they are having discussions regularly with clients about the impasse in Congress over the vote to raise the amount the government can borrow so it can continue to pay all its bills. Clients fear that politicians won't reach a deal in time, causing the country to default on its obligations — and, economists say, wreaking havoc on the global economy.

Christopher Brown, a planner in Rockville, says one client was so upset that he sold half of his stocks in a retirement account recently and parked the proceeds in a conservative money-market fund.

"He said, 'I can't go through another 2008,'" Brown says.

The government spends more than it takes in, and thus has to borrow to meet its obligations. In the past, lawmakers — even some Republicans now at the center of standoff — have raised the amount the government can borrow as a matter of routine.

Treasury Department officials say they need Congress to pass legislation now to raise the $14.29 trillion debt ceiling by Aug. 2 so the country can avoid defaulting for the first time in history.

But Republicans now are demanding that any increase in the debt ceiling be tied to spending cuts to reduce the federal deficit.

President Barack Obama has countered with a larger $4 trillion deficit reduction proposal that would include tax increases and cuts to entitlement programs. But Republicans refuse to go along with any tax increases, and some Democrats now say they'll vote against reductions to Social Security or Medicare.

The standoff prompted the Moody's Investor Service and Standard & Poor's to announce last week that it was looking at the possibility of downgrading the nation's gold-plated credit rating.

It's a fine mess — and one that's totally unnecessary.

Granted, the United States needs to reduce its deficit and get a handle on entitlement programs, particularly Medicare. But the way it's being played out in Washington — holding the debt ceiling hostage — is a cruel game of chicken that's causing small investors to fret when they shouldn't have to.

Robert Ramsay, a retired naval officer in Seabeck, Wash., called his investment adviser this month concerned that the stock market could be headed for a crash. He wanted to know what he and his wife could do to protect themselves. The 66-year-old has recovered almost all of the money he lost in the 2008 market crash and didn't want to risk losing it again.

Adding to his concerns, Ramsay and his wife receive military pensions, and he gets Social Security benefits. Obama warned last week that he can't guarantee that the federal government will send those checks out next month if the debt ceiling isn't raised. Ramsay says he and his wife would have to dip into savings to pay bills.

The retiree went through his options with the adviser, who persuaded Ramsay not to change his portfolio.

Indeed, financial planners say, the best course of action for small investors now is to stick with their long-term investment plan, instead of trying to time when to get in and out of the market.

Economists and financial professionals predict that reason ultimately will prevail, and Congress will raise the debt ceiling.

And so far, they note, the markets seem to agree. Stocks haven't taken a dive. The yield on 10-year Treasuries remains low, a sign that the government hasn't had to raise rates to attract nervous buyers.

"Why are people continuing to buy Treasuries if they think the U.S. will default?" asks Rockville planner Brown.

The assumption is that Congress will raise the debt limit because the consequences of not doing so are so severe.

If the ceiling were not raised, economists say, the Treasury Department likely would prioritize which bills get paid first. It is expected that the government would continue paying interest on the debt, but after that, it's unclear who would get the dollars left over.

Payments to seniors, the military, veterans, government contractors and anyone else receiving federal money would be in jeopardy.

"It will do significant damage to the economy, to stock prices," says Mark Zandi, chief economist with Moody's Analytics. "Interest rates will rise. The dollar will fall. It will become a complete mess."

Some Republicans in Congress say such doomsday predictions are exaggerated and the government could delay paying bills for a few days without long-term repercussions.

Not so, others say.

"It would set a precedent that would raise doubts about the long-run willingness of the U.S. government to meet its financial obligations," says David Resler, chief U.S. economist with Nomura Securities International.

Failure to pay our bills "would signal to the world that U.S. politics are so dysfunctional that we can't even avoid serious and unnecessary self-inflicted wounds," Christopher Carroll, an economics professor at the Johns Hopkins University, writes in an email. "And if we can't avoid a self-inflicted wound, the world financial markets will just freak out."

Some small investors are a bit freaked out, too.

"There is a fear," says John Bacci, a financial planner in Linthicum who averages a call a day from worried clients.

Some ask if they should abandon the stock market.

"The question then is: Where will you go?" Bacci says. Once clients see the meager rates on money- market funds and certificates of deposit, he says, that ends talk about bailing out of stocks.

Still, for those who are really nervous, Bacci has raised their positions slightly in market-neutral funds that are designed not to follow big swings in the stock market.

Jeff Sella, a planner in Rockville, is telling clients that the debt ceiling has "never not been raised before," and is encouraging them to stick with their investment strategy. But a few have reduced their stock exposure and now hold more cash.

Ronald Myers, a financial planner in Fort Lauderdale, Fla., says new clients who come to him now want to remain in cash.

"They do not want to invest in stocks or bonds until there is clarity on the debt ceiling issue," Myers says.

And existing clients aren't rebalancing portfolios as they usually do after a quarter, he says.

"Many of these clients are hesitant to do anything," he says. "It's almost like a deer in the headlights."

Many financial advisers say the debt-ceiling drama is a made-up crisis by politicians trying to score points with voters. If that's the case, it's not working with those voters who are also investors.

"They are universally disgusted," says David Berman, a financial adviser in Timonium. "That goes equally for clients who are very liberal Democrats and those we know who are very conservative Republicans."