Do They Finally Have the Guts To Downgrade the U.S.?
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While the President and Congress lock horns over the debt ceiling, the U.S. is inching closer and closer to the country's first default - at least temporarily. The Treasury estimates that it has funds to operate only until Aug. 2, 2011 - or 7 days. Even though the rhetoric and bi-partisan politics is as heated as ever, most agree that there will be some type of last minute deal that will at least temporarily fund the government. The bigger worry for the market is the potential downgrade of U.S.' pristine AAA sovereign debt rating. Both S&P and Moody's recently warned of a debt downgrade, but as PIMCO's Bill Gross asked today "Do they have the courage of their conviction?"
A downgrade of the U.S. AAA rating could have widespread ramifications, which will most immediately be felt in yields of various securities including treasuries, Agency/GSEs, and munis. President Obama described the implications like this in his speech last night:
For the first time in history, our country's Triple A credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet. Interest rates would skyrocket on credit cards, on mortgages and on car loans, which amounts to a huge tax hike on the American people. We would risk sparking a deep economic crisis - this one caused almost entirely by Washington.
S&P, in its warning, said there was at least a one-in-two likelihood that they could lower the long-term rating on the U.S. within the next 90 days. S&P still believes lawmakers will raise the debt ceiling, however if they fail to:
"if the government is forced to undergo a sudden, unplanned fiscal contraction--as a result of Treasury efforts to conserve cash and avoid default absent an agreement to raise the debt ceiling--we think that the effect on consumer sentiment, market confidence, and, thus, economic growth will likely be detrimental and long lasting. If the government misses a scheduled debt payment, we believe the effect would be even more significant and, under our criteria, would result in Standard & Poor's lowering the long-term and short-term ratings on the U.S. to 'SD' until the payment default was cured."
S&P said a downgrade may occur even if a deal is reached on the debt ceiling. Here is how they lay out a downgrade or affirmation of the AAA rating:
To some market participants S&P and Moody’s are using the debt ceiling issue to make a long-overdue move to downgrade the U.S. rating. It could easily be argued that with a debt-to-GDP ratio approaching 75 percent, the U.S. is already not “AAA” In fact, China rating agency Dagong has already downgraded the U.S. credit rating twice (currently A+) and said they would likely downgraded it again with or without a debt ceiling deal.
So any new downgrade is just a delayed version of something that should have already occurred. That said, a U.S. downgrade from S&P and Moody’s will have massive implications as it sends a clear message to U.S. and world investors that putting your money into the U.S. is not necessary a sure thing… but you knew that already.
A downgrade of the U.S. AAA rating could have widespread ramifications, which will most immediately be felt in yields of various securities including treasuries, Agency/GSEs, and munis. President Obama described the implications like this in his speech last night:
For the first time in history, our country's Triple A credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet. Interest rates would skyrocket on credit cards, on mortgages and on car loans, which amounts to a huge tax hike on the American people. We would risk sparking a deep economic crisis - this one caused almost entirely by Washington.
S&P, in its warning, said there was at least a one-in-two likelihood that they could lower the long-term rating on the U.S. within the next 90 days. S&P still believes lawmakers will raise the debt ceiling, however if they fail to:
"if the government is forced to undergo a sudden, unplanned fiscal contraction--as a result of Treasury efforts to conserve cash and avoid default absent an agreement to raise the debt ceiling--we think that the effect on consumer sentiment, market confidence, and, thus, economic growth will likely be detrimental and long lasting. If the government misses a scheduled debt payment, we believe the effect would be even more significant and, under our criteria, would result in Standard & Poor's lowering the long-term and short-term ratings on the U.S. to 'SD' until the payment default was cured."
S&P said a downgrade may occur even if a deal is reached on the debt ceiling. Here is how they lay out a downgrade or affirmation of the AAA rating:
- AFFIRM: If Congress and the Administration agree to raise the debt ceiling (with commensurate fiscal adjustments), we aim to review the details of such agreement within the next 90 days to determine whether, in our view, it is sufficient to stabilize the U.S.' medium-term debt dynamics. If we conclude that the agreement would likely achieve this end, all other things unchanged, we would expect to affirm both the long- and short-term ratings and assign a stable outlook.
- AFFIRM: If a debt ceiling agreement does not include a plan that seems likely to us to credibly stabilize the U.S.' medium-term debt dynamics but the result of the debt ceiling negotiations leads us to believe that such a plan could be negotiated within a few months, all other things unchanged, we expect to affirm both the long- and short-term ratings and assign a negative outlook, pending review of the eventual plan.
- DOWNGRADE: If such an agreement is reached, but we do not believe that it likely will stabilize the U.S.' debt dynamics, we, again all other things unchanged, would expect to lower the long-term 'AAA' rating, affirm the 'A-1+' short-term rating, and assign a negative outlook on the long-term rating.
To some market participants S&P and Moody’s are using the debt ceiling issue to make a long-overdue move to downgrade the U.S. rating. It could easily be argued that with a debt-to-GDP ratio approaching 75 percent, the U.S. is already not “AAA” In fact, China rating agency Dagong has already downgraded the U.S. credit rating twice (currently A+) and said they would likely downgraded it again with or without a debt ceiling deal.
So any new downgrade is just a delayed version of something that should have already occurred. That said, a U.S. downgrade from S&P and Moody’s will have massive implications as it sends a clear message to U.S. and world investors that putting your money into the U.S. is not necessary a sure thing… but you knew that already.
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William H. Gross, Pacific Investment Management Company, LLC (PIMCO), Standard & Poor's, Barack ObamaSign up for StreetInsider Free!
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