While many are saying that the U.S. has never defaulted on its obligations, that’s not exactly the case. Historians say that technical default has occurred five times in the country's history. In 1779, the government was unable to redeem the continental currency issued during the Revolutionary War; in 1782 the Colonies defaulted on the debt they had assumed to pay for the war; in 1862, the Union failed to redeem dollars for gold at terms stated by the debt contracts; in 1934 FDR defaulted on the debt issued to finance World War I; and in 1979, a bureaucratic snafu resulted in missed interest on some small bills. But you get the point -- default is rare and is certainly unprecedented in the age of electronic trading and an interconnected globe. In the unlikely event that politicians can’t pull it together, stocks could plunge; short-term interest rates could spike; business and consumer confidence would falter, which would cause an increase in unemployment and potentially push the economy into recession.
Since you can’t control any of those dramatic events, here are seven things you can do to prepare for the worst…while of course hoping for the best!
1. Review and replenish emergency funds: Make sure that you have an emergency fund of 6-12 months worth of expenses. If you have less than that amount, you may want to sell securities from your taxable portfolio and replenish.
2. Rebalance your investment and retirement accounts: Do not arbitrarily sell all of your investments or cash out of your retirement and college plans! But if you have not rebalanced your accounts in a while, this week would be a perfect time to do so. Make sure that your allocation matches your time horizon and your risk tolerance and don’t forget to sell company stock that has increased to more than 5 percent of your portfolio’s value.
3. Get ready to accelerate the pay down of adjustable rate loans: From mortgages to credit cards, if the worst-case debt ceiling scenario plays out, interest rates on these types of loans could rise. That may mean that you will need to refocus your available cash flow to paying down higher interest debt.
4. Lock in loans/obtain a commitment letter: Analysts are not sure whether or not longer-term interest rates will rise because of the debt ceiling. There is some evidence that when the world is in turmoil, investors have traditionally flocked to the 10-year treasury, which has kept a lid on rates. That said, since most believe that interest rates are headed higher generally, it would be advisable to secure a fixed loan now. If you have government-guaranteed student loans, you can consolidate them with the Federal Direct Loan Program.
5. Review the terms of small business loans: During the financial crisis of 2008, many small companies learned a bitter lesson: their business loans were callable. Find out the exact terms and conditions of any loans and try to work with your bank to build a contingency plan.
6. Say goodbye to German beer and French cheese: Any destabilizing event like the debt ceiling fiasco could push down the value of the U.S. dollar, making foreign imports more expensive. In those trying times, comfort yourself with Vermont cheddar and domestic beer and wine!
7. Don’t Panic: Time and time again, it has been proven that those who react emotionally at the wrong time often pay the price over the long-term. As the British say, “Keep calm and carry on.”