Like a homeowner plugging a leak in the bathroom when the entire roof is about to cave in, the Washington political establishment has been myopically obsessed with the Aug. 2 debt-ceiling deadline. To be sure, the debt limit must be raised to accommodate the deficit spending for which Congress has already voted. With a so-called “grand bargain” on the debt unlikely, the operating assumption in Washington is that the parties will strike a small deal now, fight it out during the 2012 elections and pick up debt negotiations sometime in 2013.
Yet the major bond rating agencies could force the issue a lot sooner, regardless of whether the debt limit is raised by Aug. 2.
Following up on a warning by Moody’s, Standard and Poor’s said last week it may cut the U.S. credit rating from AAA to AA within three months if there isn’t a “credible” agreement (in the $4 trillion range) to address the underlying issue — our nation’s unsustainable debt burden.
Though it’s tempting to dismiss the rating agencies’ comments as mere noise, especially given their loss of credibility after the 2008 financial crisis, the reality is that they still have tremendous influence.
True, many investors could decide that even after a downgrade, U.S. Treasuries remain a relatively safer bet than other options, such as European bonds.
However, a number of big investors are chartered to hold only AAA-rated investments, and they’d be forced to dump their U.S. bonds in the event of a downgrade. That sell-off itself would drive up our nation’s borrowing costs.
“I don’t think anybody really knows what the [interest rate] increase is, and what the chaos is going to be if the U.S. gets downgraded,” said John Cochrane, a finance professor at University of Chicago’s Booth School of Business.
Some argue that the rating agencies are bluffing and wouldn’t actually want to be responsible for the consequences of a downgrade. But investors could decide to pull their money out before the agencies act.
“Nobody can predict when the bubble bursts, when the run happens, when the earthquake goes, but we are sitting on a fault, and waiting until the election is dangerous,” Cochrane said.
If the broader investment community sours on U.S. debt, it’s conceivable that Republicans may be put in the position of having to choose between the lesser of two tax increases, with the resulting higher borrowing costs potentially exceeding the value of any proposed tax increase.
House Budget Committee Chairman Paul Ryan, R-Wis., has been skeptical that a big debt-reduction deal is possible with President Obama still in office, given the ideological differences between the two parties.
When we spoke this week, I began to ask Ryan if he thought 2013 would be too late for a debt agreement, given the recent comments of the rating agencies.
“Will the markets let us wait that long?” he interjected, completing my question. “I don’t know the answer to that. I just don’t. I really don’t. How big a down payment we get now will help determine how much time we are buying ourselves.”
Even a $4 trillion deal wouldn’t fix the long-term debt problem driven by explosive growth in the nation’s entitlement programs. Ryan noted that the budget plan he proposed, which passed the House in April, was intended to avert the European scenario, in which governments keep passing “austerity” plans to patch things over, which hinder economic growth without addressing the root problem.
“If in divided government, downgrades bring us to austerity, then we are already sort of kicking into that managed decline phase, which I so desperately want to prevent,” Ryan said.
Philip Klein is senior editorial writer for The Examiner. He can be reached at [email protected].
