Why Investors Should Care About the House Speaker Fight

What does that fight say about the GOP's ability to approve a debt-ceiling increase to stave off a financial default by the government?

House Republicans can’t come up with a speaker after three-plus days of votes and machinations.

So what does that say about their ability to approve a debt-ceiling increase to keep the federal government from defaulting on its debt in coming months? 

Nothing good – the House GOP is clearly in disarray.

Right-wing House members will likely demand extreme spending cuts in exchange for backing a debt-ceiling increase. But those cuts will likely be unacceptable to Democrats, making it difficult to forge an agreement.

If this week is any indication, mainstream Republicans will find it hard to coax their most conservative brethren into accepting a compromise accord on the debt ceiling

It’s unclear exactly when the Treasury will have to default if Congress doesn’t lift the debt ceiling, as the department has several different methods to put off the day of reckoning. But some economists estimate it will be the third quarter.

If the government does default on its debt, all hell could well break loose in financial markets and the economy. Treasury securities would almost certainly plunge, sending interest rates soaring.

Stocks Would Likely Suffer in a Default

That would almost surely be bad for your stock portfolio. Look what rising rates did to stock prices last year. It wasn’t pretty. Higher rates depress economic activity, denting corporate earnings.

Rising rates are particularly bad for growth stocks, including technology shares, because these stocks depend on high earnings growth to maintain their valuations. And again, rising rates stifle earnings.

In addition, rising yields make safe bonds (assuming any bonds are safe at that point) more attractive to investors than growth stocks are because investors now must wait longer for a strong earnings stream from growth companies.

As for fixed-income investments, the plunge in Treasurys would likely be particularly intense among Treasury bills, which have maturities of one year or less. That’s because the bonds with the shortest maturities are the ones that the government has to pay back first.

If you hold a bond fund, its price could plunge. Normally, if you hold individual Treasury bonds until maturity, you’re almost guaranteed to receive full par value when your bonds mature.

Individual Bonds Are Vulnerable, Too

But a default would put your Treasury holdings at risk. And given the importance of the Treasury market, other bonds could get hit as well. It could turn into a feeding frenzy against bonds.

Rising rates would normally make new bonds held to maturity, money-market funds and brokered certificates of deposit more attractive. But given the chaos of a default, all these get thrown into doubt.

Higher yields would also raise mortgage rates, auto-loan and credit-card rates, potentially putting a major crimp in your pocketbook.

The economy too would likely go haywire if the government defaults. Fear could paralyze companies and consumers alike. Soaring interest rates and plunging stock prices obviously won’t help the economy either.

A Treasury default could put the whole financial system at risk, given that all the players in it would have no sense of safety. 

The Treasury is the backbone of our financial system. If it can’t pay its obligations, that’s not much of a backbone.