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Friday night, after another wild day on Wall Street, the Standard & Poor (S&P) ratings agency made good on its three-month-old warning and downgraded the credit rating of the United States for the first time since it was granted in 1917. The move from AAA to AA+ reflected the ratings agency’s contention that “difficulties in bridging the gulf between political parties,” which resulted in a compromise to reduce the nation’s debt by $2 trillion, didn’t go far enough. “Political brinksmanship” made the ability of the U.S. to confront its growing debt problem “less stable, less effective and less predictable,” the agency contended.
The move capped a contentious debate between the ratings agency and government officials at the Treasury Department, who claimed S&P’s analysis was “fundamentally flawed,” according to administration sources who remained anonymous because they were unauthorized to speak about the issue publicly. Officially, the Treasury issued a statement claiming that ”a judgment flawed by a $2 trillion error speaks for itself.” S&P conceded the mistake, but John Chambers, head of sovereign ratings at the agency, claimed the error “doesn’t change the fact that [America's] debt-to-GDP ratio, under most plausible assumptions, will continue to rise over the next decade.”
And despite the Obama administration’s anger, the agency itself remained unruffled. Noting that the debt deal didn’t go far enough to “stabilize the government’s medium-term debt dynamics,” S&P also announced it was issuing a “negative outlook,” raising the possibility of additional downgrades in the next two years. S&P was looking for $4 trillion in cuts. As noted above, the current debt ceiling deal calls for half that amount — and only after additional negotiations by a 12-member committee, which aren’t due to be submitted until Thanksgiving.
S&P contended some of its assumptions were based on the idea that the committee itself could remain dysfunctional, meaning it wouldn’t come to an agreement on the additional cuts, and that the Bush-era tax cuts would remain in place past the end of 2012. These assumptions are somewhat dubious. With respect to additional cuts, there is a trigger mechanism in place should the committee fail to reach a consensus. With respect to taxes, it remains unclear as to whether those tax cuts will expire completely, remain intact, or be retained for the middle class and eliminated for higher earners.
Unsurprisingly, the reaction to the downgrade was both swift and predictable, with Democrats and Republicans reiterating their conflicting worldviews. ”The action by S&P reaffirms the need for a balanced approach to deficit reduction that combines spending cuts with revenue-raising measures like closing taxpayer-funded giveaways to billionaires, oil companies and corporate jet owners,” said Senate Majority Leader Harry Reid (D-NV). ”It is my hope this wake-up call will convince Washington Democrats that they can no longer afford to tinker around the edges of our long-term debt problem,” said House Speaker John Boehner (R-OH). “As S&P noted, reforming and preserving our entitlement programs is the ‘key to long-term fiscal sustainability,’” he added.
Other Republicans also weighed in, with presidential candidate Michele Bachmann (R-MN) calling on the president to fire Treasury Secretary Timothy Geithner, and to submit a plan to “balance the budget, not just reduce deficits.” The fire-Geithner sentiment was echoed by Sen. Jim DeMint (R-SC). ”For months [Geithner] opposed all efforts to reduce the debt in return for a debt ceiling increase. His opposition to serious spending and debt reforms has been reckless and now the American people will pay the price,” he said. Both criticisms were likely engendered by the fact that Geithner had said in April there was “no risk” the U.S. would lose its AAA rating.
Current Republican presidential front-runner Mitt Romney also weighed in. He characterized the downgrade as “a deeply troubling indicator of our country’s decline under president Obama.”
How troubling remains to be seen. If interest rates rise as a result, borrowing costs would be driven up for everything from governments at every level to rates on mortgages, credit cards and business loans. The announcement was made after the stock market closed for the weekend following a five-day span in which investors trimmed 699 points off the Dow Jones Average. That was the DJA’s worst weekly showing since October 2008.
Opinions were mixed on where we’re headed. ”I think we will have a knee-jerk reaction on Monday,” said Jack Ablin, chief investment officer at Harris Private Bank. Harvey Neiman, portfolio manager of the Neiman Large Cap Value Fund, disagreed. ”The market’s already been shaken out,” he said. “It knew it was coming.”
The initial indication of which sentiment is correct will be reflected in the opening of the Asian stock markets Monday (late Sunday night in the U.S.). Early reports suggest Asian investors are likely to retain their holdings in U.S. Treasuries, due in large part as a means of stemming gains in their own currencies versus the dollar. Currency gains make exports more expensive in a region which depends heavily on them to remain prosperous.
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