The Impact of a Potential Downgrade on the United States Credit Rating

[SixNein]

Many economists are predicting that America will get downgraded from AAA by at least one agency regardless if congress raises the debt limit. There has already been a great deal of damage caused from the political posturing in Washington. If the central government's debt gets marked down, I would also expect the same to happen to various states and companies.

How do you think this will effect you as a person?

But more importantly, do you think America is becoming ungovernable?

 

[Vanadium 50]

Why do you think it's "posturing"?

The bond rating is driven by the probability that one will get paid back. For decades, the US government has been spending more than it takes in, and if this continues, eventually bondholders will not get paid back (or will be paid back in inflate currency). I don't think this has anything to do with "governable" or "ungovernable". It's just comparing the sizes of two numbers.

If the US wants to spend x% if it's GDP on the federal government, as a lender, I'd want to see that it can sustain this level of taxes for several consecutive years, irrespective of x.

The only thing that I think is leading to "ungovernability" is the idea that 51% of the populace should pay no taxes and should decide how to spend the other 49%'s money. I don't think this is sustainable long-term.

 

[Ivan Seeking]

Many economists are predicting that America will get downgraded from AAA by at least one agency regardless if congress raises the debt limit. There has already been a great deal of damage caused from the political posturing in Washington. If the central government's debt gets marked down, I would also expect the same to happen to various states and companies.

How do you think this will effect you as a person?

It will be a defacto tax hike for everyone. It could stall the recovery and lead a double-dip recession. It could change our standing in the world forever.

But more importantly, do you think America is becoming ungovernable?

There has been one great principle that has guided our country from the beginning - politics is the art of the possible; compromise. As long as the right prides itself on a refusal to compromise an untenable position, and as long as they hold control of the house, there seems to be little hope.

When Kennedy came into office, the top marginal tax rate was 91%. Today, at 35%, our tax rates are the lowest they've been since Truman. Yet, while they waive the flag, the tea partiers refuse to give an inch for the good of the nation and they are holding Boehner hostage. What worries me is not that they will win the fight. Eventually calmer heads will prevail. What worries me is how much damage they will do before their followers figure it out.

 

[Vanadium 50]

Ivan, the President has a debt-ceiling extension with some (not a lot) bipartisan support from the House that he could sign. Many people would say it's not a very good deal, but he has it. If he chose to, he could get the Senate to pass it and he could sign it.

The fact that he doesn't think it's a good deal - and a sufficiently bad deal that default is better - is fair enough. But he does have a choice.

I don't much like the Republican plan. But I have to give them credit for having put something out there. The alternative is very murky - "I will trade you tax increases and debt limit increases today for spending cuts down the road" is very non-specific.

 

[SixNein]

Why do you think it's "posturing"?

Yes, it's pure posturing. The entire thing has mostly been about the 2012 election cycle. The entire debate has been framed for the upcoming election.

The bond rating is driven by the probability that one will get paid back. For decades, the US government has been spending more than it takes in, and if this continues, eventually bondholders will not get paid back (or will be paid back in inflate currency). I don't think this has anything to do with "governable" or "ungovernable". It's just comparing the sizes of two numbers.

The United States was on track to pay off its deficit towards the end of the 90's; however, many seen the surplus as something negative. Some argued that the surplus was a sign that the government should lower taxes and/or increase spending. In general, politicians are under extreme pressure to raise spending and lower taxes during election cycles, and they are frequently punished if they fail to deliver. The situation to me is a sign that the republic is becoming ungovernable.

If the US wants to spend x% if it's GDP on the federal government, as a lender, I'd want to see that it can sustain this level of taxes for several consecutive years, irrespective of x.

The only thing that I think is leading to "ungovernability" is the idea that 51% of the populace should pay no taxes and should decide how to spend the other 49%'s money. I don't think this is sustainable long-term.

There exists some deceitful accounting tricks in regards to who contributes to federal revenue. Every American pays payroll taxes, and those taxes are capped. The surplus of the social security fund has been going into general revenue for years. So this has essentially served as an invisible income tax that primarily effects the 51% because it is capped. I would also point out that the bottom makes contributions in other ways outside of taxes. As the lower classes are frequently the ones who fight wars.

But you are right in a sense. I think the religion of always lowering taxes and increasing spending is certainly increasing the instability of our government. In addition, America is currently going through many demographic changes. The white race will not be a majority in a few years. The majority will be minorities.

 

[SixNein]

Ivan, the President has a debt-ceiling extension with some (not a lot) bipartisan support from the House that he could sign. Many people would say it's not a very good deal, but he has it. If he chose to, he could get the Senate to pass it and he could sign it.

The fact that he doesn't think it's a good deal - and a sufficiently bad deal that default is better - is fair enough. But he does have a choice.

I don't much like the Republican plan. But I have to give them credit for having put something out there. The alternative is very murky - "I will trade you tax increases and debt limit increases today for spending cuts down the road" is very non-specific.

To put things in perspective, the democrats were risking a great deal more politically than the republicans. The republicans are going to bring up the offer made by democrats to cut entitlement spending on the campaign trail over and over again. I guarantee that it will come up in the presidential race. The democrats were simply asking for the republicans to take some risk too on the tax issue. Quite frankly, there was not a great deal of taxes involved, but there was enough to where republicans had some political stake in the bill too.

At the end of the day, seniors are the most likely group to vote. And democrats will hold all blame for cuts in entitlement spending.

 

[Pengwuino]

I'm a bit confused on this whole doomsday scenario about defaulting on debt. I was under the impression that the US was one of maybe only 2 countries in the world that have never defaulted on their debt. A quick googling shows that maybe we did once on purpose under Roosevelt for some odd reason that I'm not all that interested in. Sure we'll pay more to have debt, but some of this nonsense of saying in 2 weeks we'll become a third world nation sounds ridiculous.

 

[SixNein]

It will be a defacto tax hike for everyone. It could stall the recovery and lead a double-dip recession. It could change our standing in the world forever.



There has been one great principle that has guided our country from the beginning - politics is the art of the possible; compromise. As long as the right prides itself on a refusal to compromise an untenable position, and as long as they hold control of the house, there seems to be little hope.

When Kennedy came into office, the top marginal tax rate was 91%. Today, at 35%, our tax rates are the lowest they've been since Truman. Yet, while they waive the flag, the tea partiers refuse to give an inch for the good of the nation and they are holding Boehner hostage. What worries me is not that they will win the fight. Eventually calmer heads will prevail. What worries me is how much damage they will do before their followers figure it out.

Boehner is framing everything around the 2012 election. There are around 80 tea party seats in the house, so he could make a deal if he really wanted to do it by picking up votes by democrats and moderate republicans. Most likely, the GOP has planed to drag this out all the way through the 2012 election from the beginning. The debt ceiling is being used as a tool for the GOP to set national agenda and keep Obama tied up.

And most likely, it will be a very successful strategy for them.

 

[SixNein]

I'm a bit confused on this whole doomsday scenario about defaulting on debt. I was under the impression that the US was one of maybe only 2 countries in the world that have never defaulted on their debt. A quick googling shows that maybe we did once on purpose under Roosevelt for some odd reason that I'm not all that interested in. Sure we'll pay more to have debt, but some of this nonsense of saying in 2 weeks we'll become a third world nation sounds ridiculous.

I don't know about a 3rd world country, but a default could be very damaging. It would have the ability to trigger a full blown financial meltdown. In a basic nutshell, it would have a huge impact on our financial institutions, states, and corporate world in general.

But I doubt we'll go down that path.

 

[chiro]

The interest on new debt instruments would rise (due to higher risk), and I would hate to think of the situation of the people that have to foot the extra bill.

 

[SixNein]

The interest on new debt instruments would rise (due to higher risk), and I would hate to think of the situation of the people that have to foot the extra bill.

Just think of the housing market and all those variable loans still out. Or the massive amount of credit card debt.

 

[Pengwuino]

I don't know about a 3rd world country, but a default could be very damaging. It would have the ability to trigger a full blown financial meltdown. In a basic nutshell, it would have a huge impact on our financial institutions, states, and corporate world in general.

But I doubt we'll go down that path.

See, I don't even see how that would happen. The markets already know what's going on. I can't imagine anyone with any real financial power is going to wake up on the hypothetical day we default on debt and think "wow! I thought the US was being superbly governed and our credit to them was never something to worry about". I've heard Moody's is ready to downgrade the US regardless if we default or not.

The interest on new debt instruments would rise (due to higher risk), and I would hate to think of the situation of the people that have to foot the extra bill.

Why? We'd fall in line with pretty much the rest of the developed world. It's not like we're declaring bankruptcy. We're going to go from the absolute best rating to something a bit less if we default. We'll have to pay some more and the very fact that it looks like we can at the least talk about budget cuts and raising taxes means that this is probably the worst it can get outside of some terrible new calamity to hit the country. Sometimes I think this debt crisis is just a slow news day when you consider realistic consequences.

Just think of the housing market and all those variable loans still out. Or the massive amount of credit card debt.

Those loans aren't US public debt. It's a different system altogether.

 

[russ_watters]

There exists some deceitful accounting tricks in regards to who contributes to federal revenue. Every American pays payroll taxes, and those taxes are capped. The surplus of the social security fund has been going into general revenue for years. So this has essentially served as an invisible income tax that primarily effects the 51% because it is capped.

There is another deceitful accounting trick there, though: the fact that the benefits are deferred doesn't mean they aren't still real. If you subtract-out the future benefits, the scale for the wage tax becomes progressive again (the tax is flat, the benefits are not).

 

[Pengwuino]

There exists some deceitful accounting tricks in regards to who contributes to federal revenue. Every American pays payroll taxes, and those taxes are capped. The surplus of the social security fund has been going into general revenue for years. So this has essentially served as an invisible income tax that primarily effects the 51% because it is capped. I would also point out that the bottom makes contributions in other ways outside of taxes. As the lower classes are frequently the ones who fight wars.

That's kind of a poor argument though. Sure, lower classes fight the wars. However, lower classes use the most government resources as well. Plus the higher classes are the ones responsible for innovation and job creation (engineers and biochemists don't come cheap). You can't really say "well, this class does this and this class does that ergo disproportional taxes are fair or unfair". You are a citizen of the united states, you should pay your fair share.

The problem really is that lower classes don't really have much contact with taxes. Most of the people I know are young and thus lower class. None of them pay income tax really. Even the most inexperienced tax preparer (or hell, we have software now) can point out easy ways to have people pay no taxes (which makes me hate when people claim tax cheating is only for rich people).

I was overhearing a couple of friends once talking about taxes. One was complaining about how conservative his parents were. Neither of them pay taxes because they're students with almost no income. The guy complains "Isn't it funny how the people who pay taxes are always the ones saying they're bad". The other replied "I know, isn't that so sad?". There he was, getting government subsidized education and paying no income taxes due to him being a student (tax credits) and wondering why his parents don't love high taxes like he does. I think there is a genuine disconnect between people and the state of the tax system.

The annoying part is that the most vocal people, poor people and rich people, are the ones who will be least affected by any tax increase or decrease. It's people like my father, middle class with a side business that make enough to not be eligible for any government help or tax cuts yet not enough so that he can easily absorb any tax increase, that really would feel the effect of changes in taxes.

 

[russ_watters]

...oh, and it also requires calling retired people non contributors.

 

[mege]

...oh, and it also requires calling retired people non contributors.

Why? Many different types of retirement payouts are taxable.


@Poor fighting wars comments - They're getting paid for it. Not being forced into it. So, going into the military is a very good thing, and is probably one of the best social programs that the US has going for it (accepting your poor-do-it-more premise). Service(wo)men have worked for and earned their GI Bill, bonuses, benefits and wages.

 

[Pengwuino]

@Poor fighting wars comments - They're getting paid for it. Not being forced into it. So, going into the military is a very good thing, and is probably one of the best social programs that the US has going for it (accepting your poor-do-it-more premise). Service(wo)men have worked for and earned their GI Bill, bonuses, benefits and wages.

I fully agree with this. I could go on all day about how good the military is for some people. My nephew was circling the drain in his life out of high school. Then he joined the military. Served a term in Iraq and by the time he came home he was a changed man. He was respectful, in shape, and even wanted to become a chef. The obvious argument is that oh you could die in the military. Well being poor in the US is not exactly safe either. In fact, I wonder how many people are killed everyday in the US because they just don't live in the right neighborhood or make enough money to get out.

For some reason the military couldn't extract his laziness from him though...

 

[WhoWee]

Many economists are predicting that America will get downgraded from AAA by at least one agency regardless if congress raises the debt limit. There has already been a great deal of damage caused from the political posturing in Washington. If the central government's debt gets marked down, I would also expect the same to happen to various states and companies.

How do you think this will effect you as a person?

But more importantly, do you think America is becoming ungovernable?

First of all, the US national debt is on a tragectory to $20Trillion+ - the President's budget that was voted down 97-0 would have driven it to 25Trillion. Next, The growth projections of approximately 4% are not being met currently - new report out today will be in 1.5% to 2% range. Third and VERY important - Quantitative Easing (the printing of money) coupled with downward pressure on interet rates (to 0) are being watched very closely by the world - interest rates HAVE TO RISE. Fourth, our unfunded liabilities approximate $60Trillion to $140Trillion (opinions vary). Last, did you notice how much you paid for gasoline this morning? Energy costs are near all time highs (in spite of the great oil reserve tap-in by President Obama).

IMO - we are being downgraded because we're on an unsustainable path - and the financial sector knows it - blaming a downgrade on political sparing over this issue is naive.

http://www.naturalnews.com/032721_unfunded_liabilities_collapse.html
http://investmentwatchblog.com/total-us-unfunded-liabilities-are-estimated-at-144-trillion-roughly-1-2-million-per-taxpayer-was-that-a-pin-dropping/
http://www.americanthinker.com/2009/09/is_the_us_government_bankrupt.html

 

[BobG]

If the US credit rating is downgraded, it's because we've been mismanaging the budget ever since the FDR years; not because of one fight over the debt ceiling.

Taxes should be used solely to fund the government so the government can provide vital infrastructure for its people, defend its people, etc. If there's not enough revenue to provide the services government wants to provide, then government has cut the services it finds least important or raise taxes.

When you venture into this idea that the government can use taxes, tax cuts, and/or government spending to drive the nation's economy, then it gets into trouble. Tax cuts to tweak the economy/govt spending to tweak the economy are just two wings of the same radical idea of making government do more than it designed to do.

Traditionally, when the government has run up debts, it was almost always for legitimate reasons and the nation always had to endure a combination of higher tax rates and reduced services until the debt was paid off.

I wouldn't necessarily say running up debts during FDR's time was a horrible thing to do, but we did wind up with enough debt that paying it off wouldn't be fun at all. So Congress started finding creative ways to avoid paying the debt. High inflation rates made the debt seem smaller, so they could fool themselves into thinking they were paying off the debt even when they weren't. Not so horrible an idea - wait long enough and the debt wouldn't seem hard to pay off at all.

Except, actually, you could do that with quite a lot of debt. And it let Congressmen off the hook. Conservative Congressmen could win tax cuts and liberal Congressmen could win spending on increased services. Win, win and you'll let inflation shrink the debt.

The last decade or so, though, we've really taken that to stupid extremes. We'll fight a war and cut taxes. Then we'll bail out the nation's economy. Then we'll increase spending to increase employment (except most of that spending went to other things besides job creation - such as expanding the govt role in health care).

And now we've run the debt up so high it won't be fun to suffer while it's being paid off - and no one believes Congress would ever make Americans suffer. In fact, any Congressman that makes Americans suffer will be voted out of office. We'll never really balance the coffers by paying off that debt - and everyone knows it. And that debt puts the nation at risk when the next crisis arises - which it will.

 

[mheslep]

Many economists are predicting that America will get downgraded from AAA by at least one agency regardless if congress raises the debt limit.

No, given a raise in the debt limit the downgrade is forecast only if the federal government fails to come up with sufficient deficit reductions.

There has already been a great deal of damage caused from the political posturing in Washington.

Such as?

 

[mheslep]

...
I don't much like the Republican plan. But I have to give them credit for having put something out there. The alternative is very murky - "I will trade you tax increases and debt limit increases today for spending cuts down the road" is very non-specific.

I agree, though the the White House is vigorously pushing back against characterization that they don't have a detailed plan.
https://www.youtube.com/watch?v=AbKemPlo-2E

 

[Char. Limit]

I don't know... if I were a financial agency, I'd be downgrading too. It's obvious that Congress isn't interested in doing anything that doesn't support their political agenda, whatever it may be.

Label entire post IMHO.

 

[SixNein]

See, I don't even see how that would happen. The markets already know what's going on. I can't imagine anyone with any real financial power is going to wake up on the hypothetical day we default on debt and think "wow! I thought the US was being superbly governed and our credit to them was never something to worry about". I've heard Moody's is ready to downgrade the US regardless if we default or not.

Because the consequences of failing to raise the debt ceiling are so high, markets have been betting that congress will raise the debt limit despite all of the theatre. We are just now seeing a little bit of volatility in the market as some are getting nervous.

S&P is the one who is threatening to downgrade the AAA rating even if a default is avoided. Moody's and others are content as long as the debt limit is raised.

Those loans aren't US public debt. It's a different system altogether.

Interest rates for consumer loans are based in part on interest rates of government bonds. So if government bonds rates increase, consumer interest rates will also increase.

 

[SixNein]

Such as?

http://www.ft.com/cms/s/0/1f5b72c2-b883-11e0-8206-00144feabdc0.html#axzz1TMiqbNAc

 

[WhoWee]

Because the consequences of failing to raise the debt ceiling are so high, markets have been betting that congress will raise the debt limit despite all of the theatre. We are just now seeing a little bit of volatility in the market as some are getting nervous.

Are you talking about a 200 point drop in the DOW - after the bad manufacturing report came out today?

 

[mheslep]

http://www.ft.com/cms/s/0/1f5b72c2-b883-11e0-8206-00144feabdc0.html#axzz1TMiqbNAc

Perhaps you meant to say there 'may be damage' instead of 'already has'?

The markets’ response to the debt ceiling showdown in Washington has so far been muted...

 

[SixNein]

Perhaps you meant to say there 'may be damage' instead of 'already has'?

You have to read the rest of the article:

Money markets have begun to horde cash.
Banks are conserving liquidity.
Talk of financial Armageddon hurts consumer confidence.
Investment planning in the public sector is at a standstill.

So Washington’s endless squabbling over fiscal policy, and in recent days the mounting risk of a self-imposed calamity, have already taken their toll.

 

[SixNein]

Are you talking about a 200 point drop in the DOW - after the bad manufacturing report came out today?

Dow has been selling for 4 straight days.

http://online.wsj.com/article/BT-CO-20110727-721031.html

 

[WhoWee]

Dow has been selling for 4 straight days.

http://online.wsj.com/article/BT-CO-20110727-721031.html

I find it ironic that you picked an article that cites Caterpillar - given the stimulus - shouldn't they be trading at all time highs?

 

[mheslep]

You have to read the rest of the article:

Money markets have begun to horde cash.
Banks are conserving liquidity.
Talk of financial Armageddon hurts consumer confidence.
Investment planning in the public sector is at a standstill.

Well I would not characterize the above as a "great deal of damage." Also, one could just as easily make the argument that financial jitters are due the judgement that the current deficit reduction proposals are insufficient, and that therefore if they can't be accomplished in this environment then they never will be.

 

[russ_watters]

Any deal struck in the next few days will include no ACTUAL spending cuts, only PROMISED spending cuts. Given that Reagan agreed to a similar deal in the 80s and the spending cuts never happened, I wonder if the rating agencies care at all about the "deal" we get? Ultimately, spending cuts can only happen through a budget.

 

[WhoWee]

Any deal struck in the next few days will include no ACTUAL spending cuts, only PROMISED spending cuts. Given that Reagan agreed to a similar deal in the 80s and the spending cuts never happened, I wonder if the rating agencies care at all about the "deal" we get? Ultimately, spending cuts can only happen through a budget.

The politicians can claim cuts and spin it any way they like - but the rating agencies are more sophisticated than the voters - aren't they? Doesn't Harry Reid's plan include spending cuts related to the pull out of Iraq and Afghanistan - something that will happen regardless?

There is no escaping the fact of a $14.3Trillion debt, that QE-1 and QE-2 (printing of money) coupled with downward pressure on interest rates and high energy costs will have consequences - perhaps inflation, that $2+Trillion is needed to get the President past his re-election (attempt), the current trajectory will exceed $20Trillion, the President's last attempt at a budget would have pushed the trajectory to about $25Trillion - IF growth is 4% - not the current 2% and the lack of a budget - let alone a balanced budget moving forward.

 

[BobG]

Any deal struck in the next few days will include no ACTUAL spending cuts, only PROMISED spending cuts. Given that Reagan agreed to a similar deal in the 80s and the spending cuts never happened, I wonder if the rating agencies care at all about the "deal" we get? Ultimately, spending cuts can only happen through a budget.

I don't think they do. They only care about whether a deal is done, period. And only in the sense that this current 'crisis' is a chance for our government to prove conclusively that it's lost its mind.

Granted, the argument about the debt ceiling does provide an indication of the tone of Congress and presenting a tone that Congress just might finally be taking the idea of reducing budget deficits seriously is a positive indication. Just not something particularly significant unless it's accompanied by real action in the forthcoming budgets.

 

[mheslep]

The credit rating agencies are concerned not only with the fact of deal, but the terms of the deal.

S&P managing director John Chambers said ...

Chambers added in the interview that even if the parties agree to raise the debt ceiling, it may not be enough to avert a downgrade. Chambers said the country must implement a plan to reduce the annual budget deficit by roughly $4 trillion over 10 years, which makes the debt manageable over the long term.

http://www.washingtonpost.com/busin...s-50-percent/2011/07/14/gIQAvUzwEI_story.html

 

[WhoWee]

The credit rating agencies are concerned not only with the fact of deal, but the terms of the deal.


http://www.washingtonpost.com/busin...s-50-percent/2011/07/14/gIQAvUzwEI_story.html

Again, the politicians can spin it, posture and blame each other all day long, but there's no hiding from the facts. I have mixed feelings on S&P's statement. On one hand the clarity of their position is good - on the other they should avoid the politics.