National Debt Ceiling - What's In It For Preferred Stock Investors

Most analysts and other talking heads agree that Congress will have little choice but to raise the national debt ceiling. Having blown through their $14.3 trillion dollar ceiling last May, that ceiling must be raised by August 2 so that more spending can commence. About 37% of last year’s federal budget was financed with borrowed money (that we now owe interest on), the notion of spending within the limit being foreign to many in Washington.

As frustrating as this is, it is very likely that Congress will raise the limit. Not doing so would likely lead to a loss of the country’s AAA credit rating which would, in turn, cause an adjustment upward in the interest rate we have to pay, costing us even more money.

Further, U.S. Treasury bonds act as collateral for many other forms of debt as held by borrowers of all stripes all over the world. Lenders to those borrowers would likely insist on additional collateral in the event of a downgrade of those U.S. bonds. You can just hear the dominoes starting to fall in this scenario as borrowers are forced to unexpectedly sell off other assets in a fire sale in an attempt to meet lender demands.

There is also the risk of default since the U.S. Treasury says that it would not have the cash to pay the interest on our past debt unless the ceiling is raised so that we can borrow more money. If you are thinking that this sounds like getting a cash advance on a credit card in order to make the minimum payment due on other credit cards that you have already maxed out you are exactly correct. Borrowing money to pay off another loan is a very slippery slope, but this is the slope that we now find ourselves on.

For preferred stock investors, not raising the debt ceiling is a double-edged sword. The resulting upward pressure on interest rates would force companies to offer higher dividends on newly issued preferred stocks (good news for buyers). And the value, as reflected by the daily market price, of existing lower dividend payers would likely go down. Such lower preferred stock prices would also be good news for bargain hunting buyers but bad news if you were considering selling your preferred stock shares over the next few months.

Always remember that preferred stock investors make their money based on the number of dividend paying shares they own rather than their original purchase price or the current market price. For us, unlike common stock investing, preferred stock investing is all about accumulating shares.

While it is likely that Congress will raise the national debt ceiling by August 2, if they fail to do so preferred stock buyers should look for short-term buying opportunities in the form of higher coupon rates on new offerings and bargain basement prices for existing preferred stock issues.

Many Happy Returns.