Despite the debt limit deal that Democrats and Republicans in Congress managed to hammer out at the 11th hour this week, the U.S. Treasury is still facing the threat of a credit rating downgrade.
Last week, an executive at one of the major credit-rating agencies, Standard & Poor’s, told a congressional subcommittee that the agency would not rule out a downgrade even if Washington managed to work out a deal to avoid default. “We’re waiting to see what the final proposal is,” said S&P president Deven Sharma, according to The Wall Street Journal.
According to some reports, S&P still wants the federal government to agree on a $4 trillion debt reduction plan. That was the “grand bargain” that President Obama had hoped to forge with House Speaker John Boehner, R-Ohio, before Boehner decided that it would be too big a lift. Now, under the not-so-grand bargain that Congress and the White House managed to agree to, the debt reductions would amount to about $2.4 trillion over 10 years. That would fall far short of $4 trillion in savings, especially if Republicans continue to insist that tax increases should be off the table, except perhaps in a “revenue neutral” way that would mean no net tax increases.
Even $4 trillion might not be enough to satisfy S&P. John Chambers, S&P’s head of sovereign ratings, reportedly said during a webinar last month for investors that $4 trillion would only be a “good down payment.”
“Now actually the $4 trillion, depending on whether it is front-loaded or back-loaded, is not going to do the trick in terms of stabilizing U.S. government debt-to-GDP ratios,” he said, according to Fox Business News. “But it takes you pretty far along. And I think a grand bargain of that nature would signal, you know, the seriousness of policy makers to address the fiscal issues of the United States, to actually stabilize the debt-to-GDP. The IMF says it takes 7.5 percent of GDP consolidation. I think we have more than that.”
But what if S&P and the other major rating agencies like Fitch and Moody’s decided that the debt ceiling deal doesn’t go far enough? After all, the initial agreement to cut about $900 billion in spending seems paltry in comparison. Another $1.5 trillion would be cut after a congressional “super committee” meets this fall to decide on recommendations for further spending cuts, and perhaps a few tax loopholes to close, for whatever constituency doesn’t contribute enough to the right politicians. In exchange, the debt ceiling would be raised about $2.4 trillion.
If the U.S. debt gets downgraded by the major rating agencies, that could set off a chain reaction of higher interest rates and decreasing economic activity, potentially destabilizing the U.S. economy and leading to a double-dip recession, exactly what the Obama administration had hoped to avoid. It’s difficult to understand why S&P or the other major credit-rating agencies would want to risk such a move, especially when the Wall Street firms who form such an important part of their clientele would be put in peril too.
Still, it wouldn’t be without precedent. One independent credit-rating agency in the U.S., a Florida-based firm called Weiss Ratings, announced last month that it was downgrading U.S. debt to C-Minus. An independent credit-rating agency in China downgraded U.S. sovereign debt less than a day after the debt deal was passed, according to CNN.
Moody’s Investors Service said Tuesday after the debt deal passed that the U.S. credit rating still might be downgraded eventually, according to Bloomberg.com. Moody's affirmed the AAA rating for now, but lowered its outlook to "negative." Fitch Ratings issued a similar statement. Treasury Secretary Tim Geithner told ABC News that he didn't know whether the U.S. credit rating would be harmed, but he feared "world confidence was damaged by this spectacle." Investors also reacted negatively to the debt deal, sending the Dow plunging nearly 266 points on Tuesday.
It’s hard to believe that only a little over a year ago, the credit-rating agencies were in danger of losing their place in the U.S. financial system during the run-up to the passage of the financial reform bill. Lawmakers blamed the rating agencies for helping precipitate the financial crisis by giving high ratings to questionable mortgage-backed securities to satisfy the demands of their banking clients. Still, thanks to intense lobbying by the financial industry, the rating agencies were able to win concessions from lawmakers, and managed to beat back many of the more serious reforms that had been proposed.
They now appear to be freshly emboldened by the debt limit debate and ready to flex their muscles over the future of the U.S. economy. After all, that worked out so well in countries like Greece, where downgrades of sovereign debt forced austerity measures despite protests by thousands of outraged citizens.
Maybe it’s payback time for when the agencies felt in peril at the hands of Congress. But let’s just hope the New York-based agencies remember that their financial support ultimately depends upon the health of the U.S. economy.
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