The Effects of the Government Shutdown

The shutdown of the United States government has been all over the news in the past month. Therefore we thought it would be interesting to look at how financial markets were affected before and after the shutdown along with what could have happened if the shutdown continued.

The U.S. government shutdown began on October 1, 2013 when congress could not pass a budget for the 2014 fiscal year. This was mainly over the issue of Obamacare. Republicans did not wish to fund this program and could not develop a resolution with Democrats before the September 30^th deadline. With no budget, the Federal government could not be funded and had to be shutdown. The government reopened on October 17^th which prevented the U.S. from defaulting on its loans.

The money market during this period varied depending on the maturity of the bond. Yields of 1-month bonds initially jumped to .10 and peaked at .32 on the 15^th. As for 3-month bonds yields steadily rose during this period and peaked at .14 on the 15^th. The yields on long term bonds were relatively unchanged however. One year bonds only varied by .05 and all of the longer maturity bonds had even less variation. After the shutdown, 1-month bonds and three month bonds returned to their pre-shutdown yields within a day or two. Long term bond yields were once again relatively unchanged. The see a complete chart of these yields, use the following link: yield chart. The minimum variation in the long term bonds and the return of the short term bonds to their normal level shows that investors still view U.S. bonds as a safe investment. Had this not been the case, short term yields would have remained at a higher rate and long term yields would have gone up as well.

The financial markets fared differently. From October 1^st through the 9^th the Dow Jones, NASDAQ, and S&P 500 all fell. However, they all started to rise before the government reopened. This could be attributed to Democrats and Republicans moving towards making an agreement, but there can also be a variety of other factors involved. An in depth analysis would have to be conducted to see which factors were causing this rise and by how much. After the shutdown ended, each of the indexes dropped but recovered to over the opening value of the first day. Now they are all above the pre-shutdown rate and the S&P 500 is at a 52 week high. This trend could be contributed to an increase in consumer confidence, but once again there could be many factors involved.

What is scary is to look at what could’ve happened had the government not reopened and defaulted on its loans. It is unclear what exactly would’ve happened, but here is a chain of events that could be considered the worst case scenario. Initially there could’ve been a global stock market crash. Some predictions say the Dow Jones could have fell by as much as 1000 points and the Asian and European markets would be hit soon as well. This would then lead to a global recession as many people would lose the bulk of their assets. As the stocks dropped, investors would also rush to withdraw their funds in money markets. This would cause a collapse of the money markets since they would have a funding shortage. The collapse of the money markets would cause a run on banks which would not be able to be fully prevented by government bailouts. Only the strongest banks would be able to survive and all of the others would fail since the government wouldn’t be able to bailout all of them. Finally, lending would seize up since funds would not be available due to so many bank failures. Even though this situation is a worst case scenario, it is for the best that the government avoided even the slightest chance of this occurring.