econscius

US “AAA” Credit Rating Downgrade Was Expected

In Debt Ceiling, Economy, Federal Deficit on July 28, 2011 at 4:32 am

Go to fullsize image

We cannot say we were not forewarned about a possible drop in the S&P rating for sovereign debt of the United States from the gold standard of “AAA”.   Back in April 2011, S&P cut its outlook on US debt from “stable” to “negative” on account of the mounting deficit.

I think the current political battle over raising the Debt Ceiling will end with an eleventh hour deal but the Federal Government’s credit rating may be cut, anyway, even with a deal that avoids a default.  Mr. Deven Sharma, president of Standard & Poor’s, told a US House subcommittee the US would need to work out a deficit reduction package of about $4 trillion over the next decade for the nation to keep its “AAA” rating. [1]  The Boehner and Reid deals now on the table fall well short of $4 trillion and President Obama’s original request was for a Debt Ceiling increase with no deficit reduction at all.

If the rating is dropped from “AAA”, there will be much partisan blame over who caused it.  The good news is a drop to “AA+” is hardly a high risk rating, putting the USA at the same rating as Belgium.  There will be short-term portfolio churn as some pensions and money market funds require holdings to be “AAA”.  Other buyers are likely to step up for US debt, though probably at slightly higher yields.  Nevertheless, the blow to American prestige will be enormous. 

Do not blame the ratings agencies who are simply messengers of the bad news.  The fact is a ratings downgrade becomes inevitable when servicing the debt becomes more risky.

Do not let politicians mislead you into thinking a ratings downgrade unexpectedly popped up out of nowhere.  We have been warned many times the past three years as seen in this sample of headlines:

“S&P says pressure building on U.S. “AAA” rating,” Reuters, Sept. 17, 2008 [2]

“Moody’s Says U.S. Debt Could Test Triple-A Rating”, New York Times, March 16, 2010 [3]

“Moody’s and S&P Alert US About Credit Rating”, New York Times, January 14, 2011 [4]

“U.S. Warned on Debt Load: S&P Signals Top Credit Rating Is In Danger, Stoking Political Battle on Deficit”, Wall Street Journal, April 17, 2011 [5]

“Analysis – United States gets closer to losing its AAA rating”, Reuters, July 25, 2011 [6]

May we be forewarned about what may happen in the future.  There are many notches below “AA+” a profligate United States may gradually be cut to.  Most ominous is how continuous growth in the deficit relative to GDP exposes the US to higher interest rates whenever the rate environment turns up.  The deficit then grows as the debt used to pay that interest is added onto old debt.  A 3% increase in average interest costs on a $15 trillion debt amounts to $0.45 trillion in new interest expense each year.  Most 30-year bonds will not adjust any time soon, but short-term T-bills roll over every month, reseting to the latest interest rates.  

 

[1] http://www.csmonitor.com/Business/2011/0727/US-debt-downgrade-is-possible-not-inevitable

[2] http://www.reuters.com/article/2008/09/17/us-usa-rating-sandp-idUKN1752966920080917

[3] http://www.nytimes.com/2010/03/16/business/global/16rating.html?adxnnl=1&ref=moodyscorporation&adxnnlx=1311824019-0Pn17TP47seMxuN11WzntQ

[4] http://www.nytimes.com/2011/01/14/business/economy/14place.html?_r=1&ref=standardandpoors which refers to Moody’s report: http://graphics8.nytimes.com/packages/pdf/business/AaaSovereignMonitor-January2011.pdf

[5] http://online.wsj.com/article/SB10001424052748704004004576270693061767996.html

[6]  http://uk.reuters.com/article/2011/07/25/uk-usa-debt-downgrades-idUKTRE76O0DE20110725

Advertisements
  1. Why can’t we get the politicians to do the work of the people?

  2. Good question! I fear there are many answers but I think the biggest issue is the politicians mostly vote what they feel their constituents want.

    The US House has Representatives who represent districts with a lot of indigent residents who tend to favor higher government spending and more redistributionist policies. Other Representatives come from higher-income and more culturally individualist areas where the voters tend to want lower taxes and lower spending. When the control of Congress and the Presidency is split, there may be no obvious winner in this competition.

    There is an argument many voters send conflicting messages. Many polls show the average voter wants less spending – but less spending in areas that do not impact them personally. Many polls show average voters want higher taxes on someone else, but feel they personally pay enough already. In theory, most people like the idea of eliminating “loopholes” but some of us probably send conflicting messages if we are saying “keep my mortgage deduction”, “keep my college loan interest deduction”, etc.

    I do not pretend there is an easy answer. Most of us will have to sacrifice in some ways, be it reduced tax deductions (“loopholes”), reduced government programs and/or higher taxes paid.

    Thanks for reading!

  3. I would ammend your comment about Reps voting for what constituents want to “voting for what PAYING constituents want.” Therein lies the rub, but I think the failure of Boehner to get a debt ceiling bill passed yesterday may be a good thing.

  4. Yes, “paying constituents want” is a good point. In the end, though, I think we need to get the Debt Ceiling raised. I’ve read plenty of articles on Bloomberg and Marketwatch from market participants point out it is not actually a default until we miss an interest payment, which we would not have to do since payments can be prioritized. They also argue the Debt Ceiling is way overplayed and no disaster should be expected. But… the fact is no one really knows and I think there is always a chance of a panic contagion. Seems to me the best thing is to get a really good deal (real future spending cuts not Washington smoke-and-mirrors) in exchange for raising the Debt Ceiling on time.

  5. […] refer readers back to my July 28 post on why an S&P downgrade has been looming for years: https://econscius.wordpress.com/2011/07/28/us-aaa-credit-rating-downgrade-was-expected/.  There is no joy in being proven right just because I have spent years saying this […]

  6. […] Mr. Robinson says the downgrade has Republican “footprints” because he thinks S&P is afraid the GOP will force a default.  He says, “This isn’t the rationale that S&P gave, but it’s the only one that makes sense”.  Many on the Left are trying to blame the downgrade not on the party in power but on Republicans (see: https://econscius.wordpress.com/2011/08/07/jay-carneys-4-trillion-lie/).  Never mind S&P’s own words about the growing debt or their repeated warnings in recent years, warnings issued before there even was a Tea Party (see https://econscius.wordpress.com/2011/07/28/us-aaa-credit-rating-downgrade-was-expected/). […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: