A Looming Downgrade?

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America continues to be rapt — and perhaps alarmed — by the ongoing debt ceiling negotiations. Yet even as the negotiations proceed, a daunting reality has been largely obscured. Other than preventing a default on August 2nd, these negotiations, including any of the current permutations referred to as “grand bargains,” could end up producing nothing more than getting us back to where we are right now. Why? Because a deal that only avoids a credit “default” and not a “downgrade” may be equally devastating. In short, if the credit rating of the country is lowered, the ensuing rise in interest rates would virtually cancel out all the long-term savings proposed by either side.

A credit rating reflects an extensive analysis of how well a particular entity — in this case the federal government of the United States — can service its underlying loans. The current credit rating of the United States is AAA, which is the safest credit rating there is. America has had an AAA rating since 1917, when Moody’s first began such assignments.

Back in April, long before the debt ceiling debate reached the fevered pitch it has currently assumed, one of those ratings agencies, Standard & Poor’s, lowered the nation’s outlook regarding its long-term credit rating from “stable” to “negative.” That change was essentially a warning that if America did not get its debt under control, there was a one-in-three chance that S&P would lower the AAA rating over the next two years.

A scant three months later, S&P had upped the ante to a fifty-fifty chance over the ensuing three months, and possibly as early as August. The principal impetus for such a downgrade would be a deal whereby the U.S. raises the debt ceiling, but does nothing to address ongoing deficits. “Under this scenario, we expect that interest rates could rise–say, 50 bps on short-term rates and double that on the long end–though this may depend on whether Treasuries would lose their status as the safe haven that investors have historically perceived them to be, or whether physical assets such as gold would benefit from such a flight to quality,” S&P said. In other words, interest rates could go even higher if the world no longer views America as the ultimate port in any financial storm.

Historically speaking, interest rates are near all-time lows, meaning the U.S. can borrow money at incredibly cheap rates. Despite that reality, interest payments on the debt were over $413 billion in 2010, and more than $385 billion in the first nine months of FY2011. $413 billion of interest on $14 trillion of debt comes to about 3 percent. Roughly speaking, a one percent rise in interest rates would add another $140 billion of interest payments to the existing debt. More debt? More interest. Higher interest payments? Greater and greater amounts of debt.

Former Federal Reserve governor Lawrence B. Lindsay explains the implications. “At present, the average cost of Treasury borrowing is 2.5%,” he writes. “The average over the last two decades was 5.7%. Should we ramp up to the higher number, annual interest expenses would be roughly $420 billion higher in 2014 and $700 billion higher in 2020.” Multiply the low number by the same ten years, and the most ambitious “grand bargain” of $4 trillion of “savings” currently proposed yields no savings whatsoever.

Mr. Lindsay then cuts to the heart of the class-warfare rhetoric promoted by Democrats. “There is no way to raise taxes enough to cover these problems. The tax-the-rich proposals of the Obama administration raise about $700 billion, less than a fifth of the budgetary consequences of the excess economic growth projected in their forecast.” The excess growth Mr. Lindsay refers to is the administration’s rosy scenario of 4, 4.5 and 4.2 percent in 2012, 2013 and 2014, respectively. The Federal Reserve has already punched a hole in the 2012 number, projecting a top rate of 3.7 percent for next year. Bottom line? “Only serious long-term spending reduction in the entitlement area can begin to address the nation’s deficit and debt problems,” Mr. Lindsay warns.

So who’s offering what? On the Republican side, House Speaker John Boehner is proceeding with a plan that offers approximately $3 trillion in spending cuts over ten years, but requires a two-step process to raise the debt ceiling. The first step is a hike of $900 billion with slightly more in the way of cuts, followed by the formation of a 12-member committee tasked with finding an additional $1.8 trillion in savings. Senate Leader Harry Reid declared that plan “dead on arrival”  in the Senate, and the Obama administration issued a formal veto threat. Furthermore, in a late-breaking development, the Washington Post is reporting that some house Republicans won’t support the plan without assurances that a Balanced Budget Amendment, both voted on in Congress and sent to the states for ratification, is part of the deal.

On the Democrat side, Mr. Reid is reportedly keeping his latest plan under wraps as a “fallback when Boehner’s [bill] fails,” according to an unnamed Democratic official. What’s currently available contains $2.7 trillion in spending cuts, no tax hikes, and a rise in the debt ceiling “until 2013,” because Democrats and the president do not want to re-visit this “problem” (read: possible tax hikes) until after the 2012 election. In this plan, $1 trillion in savings is based on “winding down” the wars in Iraq and Afghanistan. This seems to contradict the president’s assertion that whatever occurs with regard to those wars would be decided by “events on the ground.” House Republican Leader Eric Cantor characterizes the plan as a “blank check.”

In addition, lawmakers are still holding bipartisan talks aimed at reconciling their differences.

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  • teabagger4life

    Let’s hear the excuses from the head muslim. Its Bush’s fault, racism and the republicans are out to get him. No, the head mooslim is a true loser. He spending is totally put of control making government bigger everyday. 2012 can’t come fast enough. One and done. The “great one” then can play golf more that he does now, if that’s possible. The best is that we don’t have to continue to listen to his bs. and look at the ugly lying puss.

  • Philip Arlington

    Of course it is possible to raise taxes sufficiently, but not by taxing the rich alone. All combined tax take of all tiers of government in the US is about 30% of GDP. Many developed countries are closer to 40%. I would posit that you can't run an effective developed country on a tax take of 30%. The best evidence for this is the case of the United States, which has been run by the Republics for eight of the last ten years. (You can run a developing country on that take, but the U.S. is not a developing country).

    So you need to massively increase taxes for everyone on average incomes and above. And then you need to slash defence spending and the total cost of the health care system as well. Note I said total cost of the healthcare system, not just Medicare. Private health insurance also needs to get much cheaper, so that middle class Americans will be able to afford it out of smaller after tax incomes. This can be done because American healthcare is grotesquely inefficient: the Japanese get twice as much bang for their healthcare buck.

    The standard of living of most of the U.S. population is going to fall, there is no way around that, but you should do it in a way that doesn't terminate the investment you need to make to be competitive in the future. This isn't the 19th century, when a sparsely populated country could get rich by the low standards of the time through private exploitation of abundant natural resources. Today, no country can remain globally competitive without a high level of tax-funded investment in education, science and infrastructure.

    • StephenD

      What percentage of your income does it take to ADMINISTER the protection of your home and conduct business for your family? If that takes more than 30%… you’re doing it wrong!

  • Dennis

    Hello Philip! Please research the FAIR TAX. Neal Boortz has lots of information on his website.- http://www.boortz.com. The U.S. needs a self-limiting tax approach that severely limits the IRS's scope of activity and staff. The U.S. needs a method to keep politicians from getting into everyone's pockets. Again FAIR TAX. BTW…How do you explain Hong Kong, Singapore, etc success? Do those countries invest a lot of money in education? We taxpayers get hit for a lot of money for education, but it seems we get no bang for our bucks. Bring back TRADE SCHOOLS…everyone DOES NOT need college in this age of specialization.

    StephenD, you are on the right track. If you're speaking about Fed government, it really needs to max at 15%. States and local governments can handle most functions but they cannot print money, thus, they are restricted to what their residents will tolerate. Private or personal expenditures vary, but the one big thing is Mortgage / Rent and that should not be higher than 24% – 25% of Take-Home $$$. That is usually FIXED and the rest of the outlays are VARIABLE.

    Re education in a non-19th century environment, there are so many ways to achieve an education that will not cost you $30K – $50K per year. Do the research into that as well as PROFESSIONAL LICENSES for various professions…lots of options out there.

  • Fred Dawes

    Let it happen and see what we get?

  • WilliamJamesWard

    "Tax and spend liberalism or compassionate conservatism", my big toe, why not
    "bleed and steal". Obama who knows he will not be around to long knows to
    get it all now and not work the beast (us) but cut the throat and drain it all and
    when done sell the hide. Like all politicians after it is all done and said, they can
    blame each other, walk away and count their ill gotten gains while the citizen is
    left holding the bag, Uncle Sam in rags, the ideal for leftists, Republicans will
    gladly sell everything we loose back to us for another cycle of rebuild and default.
    Americans can you not think of and honest way to run government and handle
    finances?. Shovel ready jobs are in criminal prosecution, Washington D.C. is ripe
    for cleansing and we can build enough prisons to hold all of the vermin.

  • LindaRivera

    An inferior health care plan that no one wants and CANNOT afford to pay. The threat to jail and/or fine those who don't purchase the government enforced plan.

    Massive spending as if there is no tomorrow. Fighting wars we have no money for. Massive borrowing. The Massive giving away of Billions of dollars every year to other countries, including the oil-wealthy Middle East, Hamas-controlled Gaza and the Palestinian Authority organization who fill their war chests, build mansions and laugh all the way to the bank with free infidel money. Whilst in America, homeless shelters are filled to capacity; tent cities have sprung up all over the U.S. filled with desperate, jobless, homeless, NEGLECTED Americans.

    Massive debt. The massive printing of paper money out of thin air to DELIBERATELY create out-of-control inflation. There is no question that the total DESTRUCTION of America's economy is planned. The results will be horrifying. In the once wealthy and great nation of America, millions of Americans will become destitute, hungry and homeless with no money or resources to help them.

  • LindaRivera

    Organic, non-gmo avocado, fruit and nut trees and berries must be planted in all of our nation’s cities’ and towns’ parks to help the many millions of Americans who will soon be in a desperate struggle to survive.

    Watch it. And weep for our great nation and people:

    FALL Of The Republic – The Presidency Of Barack H Obama – The Full Movie HQ http://www.youtube.com/watch?v=F8LPNRI_6T8&fe