By Carrie Budoff Brown, Ben White | Politico – Wed, Jul 27, 2011It’s not the default that strikes the most fear in the White House and Congress these days. It’s the downgrade.
Even Republican leaders say the country can’t go into default, and they’ll do everything possible to raise the debt limit by Aug. 2.
But what really haunts the administration is the very real prospect, stoked two weeks ago by Standard & Poor’s, that Barack Obama could go down in history as the president who presided over his country’s loss of its gold-plated, triple-A bond rating.
Obama could win and lose at the same time, striking a deal to avoid default but failing to pass muster on the substance of that deal with credit agencies, which could go ahead and downgrade the rating anyway.
Financial analysts say such a move would hit Americans with more than $100 billion a year in higher borrowing costs, but it’s not just that. It would be a psychic blow to a nation that already looks over its shoulder at rising economic powers like China and wonders, what’s gone wrong? And it would give the president’s Republican rivals a ready-made line of attack that he’s dragging the country in the wrong direction.
It’s what drives his Treasury Department into cajoling and pleading with the bond ratings agencies to be patient, like a harried coach working the refs from the sidelines.
It’s a factor influencing Obama’s rejection of a short-term deal: The administration believes the ratings agencies won’t like it.
And it’s what gives these little-known firms a powerful club that they’re wielding with gusto over Washington policy-makers. They hope to force a deal that not only raises the debt ceiling but also makes deep cuts in government spending and eats into the nation’s deficit.
The threat of a downgrade “is very damaging to all of us, and that would be a product of the dysfunction of Congress” said Rep. Peter Welch (D-Vt.), who led a faction of House Democrats who argued for a “clean” debt-limit increase early in the process, only to watch escalating chatter about the “Armageddon” of a missed deal feed scrutiny of the nation’s fiscal health.
S&P raised the threat of a downgrade July 14 by declaring that raising the debt limit alone might not be enough. It wanted to see an enforceable agreement to cut $4 trillion over 10 years to affirm the triple-A rating.
Administration officials were shocked by the move. They suggested privately that it did not seem to square with prior S&P reports, which said the nation’s larger budget problems could be dealt with over several years. Some administration officials dismissed the S&P report as little more than amateur political prognostication by people with limited understanding of how Washington works.
But the White House’s statements in the past week show a downgrade is now top of mind. Obama himself invoked the country’s triple-A rating in a rare prime-time address Monday as he outlined the consequences of default.
“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,” Obama said. “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.”
Nearly every debt-limit conversation on Capitol Hill is infused with debate over the potential for either a downgrade, a default, or both. Democrats have embraced the argument of the White House: A short-term plan could result in a debilitating downgrade even if default is avoided.
Republicans are moving forward with their two-phase plan, but they’ve shown some concern about the possibility of ratings agencies scarring America’s creditworthiness. There’s significant disagreement in the GOP about the prospects of default and downgrade, and some lawmakers believe the administration and congressional leaders have created a false panic to box them into voting to raise the debt ceiling.
“The reality is these rating agencies have no idea how to rate a $17 trillion economy like the United States,” Rep. Darrell Issa (R-Calif.) told radio host Don Imus on Monday. “They have no idea how to rate the debt worthiness of a $14 trillion debt like the United States.”
The truth is that Capitol Hill has less insight into the workings of the marketplace than the investment gurus on Wall Street, and even they have varying views on the potential for a downgrade.
There is also no clear sense of how the ratings agencies would ultimately judge the two major plans in the mix.
The Senate Democratic proposal calls for a one-time increase in the debt limit through the 2012 elections coupled with $1.7 trillion in spending cuts and about $1 trillion in savings from winding down the Iraq and Afghanistan wars.
The House Republican bill would raise the debt limit in two phases and mandate a deficit cut of $3 trillion.
But the second debt limit increase next year would depend on Congress adopting the recommendations of new 12-member legislative committee for $1.8 trillion in cuts — far from certain, given the polarized political environment. That lack of certainty could raise concerns with the ratings agencies, Democrats said.
Aiming for any ounce of advantage, Senate Majority Leader Harry Reid (D-Nev.) argued Tuesday that his plan would shield the country from a ratings drop, while Boehner’s plan would not — a statement Boehner’s office contested.
“The $3 trillion House plan is the only one on the table that forces Congress to take on the drivers of our debt,” said Boehner spokesman Brendan Buck, adding that the Reid plan relies on war savings, “an accounting gimmick that will have zero real-world impact on our deficit.”
On a Tuesday conference call with reporters, bank analysts predicted the odds of a default are close to zero, but warned that a downgrade is a growing possibility.
An agreement that sustains a top-notch rating would have to include $3 trillion to $4 trillion in budget deficit cuts over the next decade, said Terry Belton, global head of fixed income strategy at JPMorgan Chase.
Not just that, said Mike Hanson, senior U.S. economist at Bank of America Merrill Lynch, but credit agencies also want the ultimate plan to have strong bipartisan backing.
“It really is important that we need to have a deal that is fairly comprehensive and has fairly broad support,” Hanson stressed.
A single downgrade might have limited market impact. But a move by all three main ratings agencies — S&P, Moody’s Investor Service and Fitch Ratings — would likely force huge investment funds that must hold only the safest of bonds to sell en masse. The scary headlines associated with a first-in-history downgrade also could cause smaller investors to panic and dump stocks.
In a recent interview with POLITICO, David T. Beers, head of sovereign ratings at S&P, said the July 14th report was not a major shift and simply reflected an increased concern that there is no clear path to significant deficit reduction.
“What we are focused on is not the debt ceiling but the underlying state of public finances,” said Beers, a London-based executive who has conducted multiple meetings with administration officials.
In order to maintain a triple-A rating, Beers said, “what would have to emerge would be something that has a material impact on the underlying fiscal issues.”
“None of us know what this agreement is going to look like,” Beers said. “For us to think it is credible it would first of all have to show some choices about what the fiscal priorities are and be actionable in ways that would give us confidence that it is going to be implemented.”
Josh Boak and Jonathan Allen contributed to this report. (Editor's Note: So Mr. Obama... how's that hope and change coming along????)
