Tuesday, July 19, 2011

Standard & Poor's Underscores: Merely Lifting Debt Ceiling is NOT Enough to Preserve AAA Credit

A Standard & Poor's report dated July 15, the day after it threatened to downgrade U.S. debt if a debt-bending deal is not reached, underscores what I've been writing about: that merely lifting the debt ceiling, or authorizing a so-called "Debt Commission" to propose further spending cuts by the end of the year, is not enough to ensure that U.S. debt is not downgraded to AA status, with enormous "knock-on" effects to the rest of the economy. The salient portion, with my emphasis added:
The action on the U.S. government's 'AAA' long-term and 'A-1+' short-term ratings reflects our view of two issues: the failure to raise the federal debt ceiling so as to ensure that the government will be able to continue to make scheduled payments on its obligations, and our view of the likelihood that Congress and the Obama Administration will agree upon a credible, medium-term fiscal consolidation plan in the foreseeable future. (See "United States Of America 'AAA/A-1+' Ratings Placed On CreditWatch Negative On Rising Risk Of Policy Stalemate," published July 14, 2011.)

As it stands, we see at least a one-in-two likelihood that we could lower the long-term rating on the U.S. within the next three months-–by one or more notches, into the 'AA' category–-if we conclude that Washington hasn't reached agreement on the latter of these two issues.
Let's repeat that: S&P is likely to downgrade U.S. debt if the nation either fails to lift the cap or fails to reassure ratings agencies that it's serious about "credible, medium-term fiscal consolidation" -- i.e., bending the debt curve. And S&P's earlier report clearly defined "credible, medium-term fiscal consolidation plan" as one in the roughly $4 trillion range, involving some "mix" of spending cuts and revenue enhancement, involving compromises by both parties, put in place sooner rather than later.

In other words: not the McConnell plan (which merely lifts the debt ceiling, albeit in a complicated way); not the Reid-McConnell plan (which lifts the debt ceiling and makes small spending cuts but otherwise kicks the can down the road to a so-called "deficit commission"); and not "Cut, Cap & Balance" (which is pure showmanship, not designed to pass).

Meanwhile, the bad news isn't limited to the government itself. The foreseeable "knock-on" effects are already happening: New York Life, Northwestern Mutual, and other blue-chip insurers, and Fannie Mae, Freddie Mac, and home and farm loan banks were placed on notice of possible downgrades Friday, and Moody's placed five states (Virginia, Maryland, New Mexico, South Carolina, and Tennessee) on downgrade notice today. Because, as S&P says, "no financial institution can carry a higher rating or outlook than its sovereign," the entire U.S. economy will be degraded, either directly or indirectly, if the U.S. government is downgraded.

Far from being bad actors, the ratings agencies are trying very hard not to downgrade U.S. debt, even though there is increasing concern in financial markets that there is too much nominally AAA debt out there already. No, the agencies are not the bad guys here; like Paul Revere, they keep sounding the warning (as here, here and here).

Is anybody in Washington listening?


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