S&P warns U.S. must get control of its debt

April 19, 2011

Yesterday, Standard & Poor’s (S&P), a credit ratings agency, reduced the outlook on the United States’ AAA credit rating from “stable” to “negative.” The report is not a reduction in the U.S.’s credit rating, but a gauge of the country’s ability to maintain the AAA rating.

The downgrade is a reaction to Washington’s inability to come to a consensus on a substantive, actionable plan to reduce the public’s debt burden. In the wake of tense negotiations toward an agreement on how to fund the federal government through the end of the current fiscal year, the report is a reminder of not only the severity the issue, but also how far Congressional leaders have to go to achieve real reforms leading to significant debt reduction.

S&P’s actions indicate the U.S. faces a one in three chance the nation’s credit rating could be downgraded in the next two years. According to S&P:

If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.

Reuters explains what a downgrade would mean for the U.S.:

A downgrade, which would leave Germany and France with a higher rating, would erode the status of the United States as the world’s most powerful economy and the dollar’s role as the dominant global currency.

If investors start demanding higher returns for holding riskier U.S. debt, the rise in bond yields would crank up borrowing costs for consumers and businesses. That would threaten to hurt the economy as it recovers from the worst recession since World War II.

“This new warning highlights the need for the U.S. to take better control of its fiscal destiny if it is to avoid higher borrowing costs and maintain its central role at the core of the global economy,” said Mohamed El-Erian, chief executive at PIMCO, which oversees $1.2 trillion in assets and has a short position on U.S. government debt.

The news hit the stock market hard, causing major domestic indexes to fall more than one percent.

In reaction to the report there was also push-back from some, pointing to S&P’s failures in the past and asserting the agency isn’t an authority on Washington’s budget negotiations. Politico’s Morning Money highlighted the questions from the Treasury Department:

Treasury pushed back hard on the significance of S&P changing its outlook on U.S. debt to negative. They had plenty of help as many smart observers across the blogosphere and in the markets dismissed the rating agency action as a.) not a “downgrade” as the triple-A rating remained; b.) not terribly credible given S&P’s past failures; c.) not worthy of much more than a news brief; and d.) not taken seriously by the market as Treasuries advanced and the initial stock market swoon eased as the day went on.

The Atlantic’s James Fallows says:

S&P knows nothing more about U.S. budget prospects than you or I do. They’re saying they have an opinion on the state of Congressional-White house dealings on the budget. Fine. Go on a talk show or start a blog. … What I’d really like to know is who S&P likes in the Hornets-Lakers series, or this season of American Idol. Their views would carry just as much weight. Also I’d like to know why the news ecology treated this as such a big deal.

Beyond the skepticism arising in the wake of S&P’s report, the message so prevalent in most news stories still remains relevant (and not terribly surprising). The White House and Congressional leaders have not made any indication that they are close to coming together and working towards a substantive, bipartisan plan to reduce spending and control the rapid rate at which the national debt is rising. Until that happens, this type of news will surely become more commonplace.

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