U.S. Credit Rating May Be Cut by S&P Unless Lawmakers Agree to Reduce Debt

Standard & Poor’s put the U.S. government on notice that it risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt.

“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,” New York-based S&P said today in a report that maintained its top rating on U.S. long-term debt while lowering the outlook to “negative” for the first time.

S&P said there’s a one-in-three chance that the rating might be cut within two years and that its “baseline assumption” is that Congress and the Obama administration will come to terms on a plan to reduce record deficits. Treasuries and the dollar rebounded from early losses following the statement, while stocks declined. Moody’s Investor Service, which has a stable outlook on U.S. debt, today said the U.S. budget debate is “positive” for the country’s credit.

“For most investors there is nowhere else to put their money as the U.S. still has the strongest, deepest, most-liquid markets in the world,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. “There is no alternative.”

Speculation on Greece

The yield on the benchmark 10-year Treasury note jumped as high as 3.45 percent in the minutes after the S&P report from 3.37 percent. The yield was back down to 3.37 percent at 4:27 p.m. as investors focused on speculation that Greece will be unable to avoid a default, driving them to the relative safety of U.S. debt. The Standard & Poor’s 500 index was down 1.1 percent at the 4 p.m. close of trading to 1,305.14 after declining as much as 1.9 percent.

Today’s announcement marks the first time the U.S. credit outlook has been questioned since 1995 and 1996, when a dispute between then-President Bill Clinton and House Speaker Newt Gingrich led to government shutdowns. Fitch Ratings put U.S. debt on a “negative ratings watch” in November 1995 until spring 1996, and Moody’s put some U.S. government bonds on review for a possible downgrade in January 1996.

“We believe there is a material risk that U.S. policy makers might not reach an agreement on how to address medium-and long-term budgetary challenges by 2013,” S&P said in its statement today.

Pressure for Agreement

The action puts pressure on President Barack Obama and House Republicans to come to agreement on plans to reduce the national debt, which S&P says could rise to 84 percent of gross domestic product by 2013.

Photographer: Christian Keenan/Bloomberg

Moody's Senior Credit Officer Steven Hess. Close

Moody's Senior Credit Officer Steven Hess.

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Photographer: Christian Keenan/Bloomberg

Moody's Senior Credit Officer Steven Hess.

“S&P’s outlook certainly adds to motivation in Washington to confront our fiscal challenges,” said Tony Fratto, who served as a White House and U.S. Treasury official under President George W. Bush. “If economic authorities here fail to put in place a credible deficit reduction plan over the next two years, the concern is justified.”

Austan Goolsbee, Obama’s chief economic adviser, rejected the S&P’s negative outlook, calling it a “political judgment” that he said doesn’t deserve “too much weight.”

“They are saying their political judgment is that over the next two years they didn’t see a political agreement” to reduce long-term deficits, Goolsbee, chairman of the Council of Economic Advisers, told Bloomberg Television’s InBusiness with Margaret Brennan. “I don’t think that the S&P’s political judgment is right.”

$4 Trillion

Obama has proposed cutting $4 trillion in cumulative deficits within 12 years through a combination of spending cuts and tax increases. The administration is resisting Republican calls for swifter cuts, while also pushing for a set of rules to enforce spending reductions over time.

Goolsbee said Obama and Republican congressional leaders are “pretty close” in the deficit reduction targets they have announced. Each has set a $4 trillion target, though House Republicans have a timeline of 10 years and the White House proposal would cumulatively cut that amount over 12 years.

House Majority Leader Eric Cantor called the S&P warning “a wake-up call for those in Washington asking Congress to blindly increase the debt limit.”

S&P’s negative outlook “makes clear that the debt-limit increase proposed by the Obama administration must be accompanied by meaningful fiscal reforms that immediately reduce federal spending and stop our nation from digging itself further into debt,” the Virginia Republican said in a statement.

Spending, Taxes

S&P said it wasn’t taking a stand on the right mix of spending and revenue measures, saying only that any agreement must win the acceptance of a “cross section of leaders in both political parties” to be credible.

Sovereign credit quality has gained prominence as European countries from Greece to Portugal struggle to finance their debt. The Group of 20 nations named the U.S. as one of seven large economies that will face deeper scrutiny so their politics don’t derail a global expansion.

Overseas investors hold about half of the roughly $9 trillion in outstanding marketable U.S. debt, including $1.2 trillion held by China. Treasury Secretary Timothy F. Geithner has said the U.S. shouldn’t be borrowing “from the Chinese” and other foreign investors to finance tax cuts for the wealthiest Americans.

Maintaining investor confidence overseas will be a question of political credibility rather than solvency for the U.S., said Lena Komileva, global head of G10 strategy at Brown Brothers Harriman & Co in London.

Lagging Behind

“In the relative universe of sovereign credits, investors are likely to view that the current episode of U.S. actions lagging behind market expectations as transitory which will keep U.S. risk premia contained,” Komileva said. “The euro remains the epicenter of global systemic risk.”

S&P didn’t mention the $14.29 trillion debt ceiling among the risks affecting the U.S. outlook, and it noted that the U.S. has “unique external flexibility” because the dollar is the world’s most-used currency. The ratings company focused on the political calendar, saying that if current budget negotiations fail, it might not be possible to get an agreement until at least the 2014 budget cycle.

Borrowing Limit

The Treasury Department has said the borrowing limit will be reached no later than May 16, at which point it will turn to emergency measures that provide borrowing room through about July 8. Republican leaders in Congress have said they won’t back increasing the debt ceiling unless Obama agrees to more specific steps to trim the budget deficit, estimated to top $1.6 trillion this year.

Alan Krueger, the Treasury’s former chief economist and an economics professor at Princeton University in New Jersey, said the record of S&P during the financial crisis has watered down the impact of its pronouncements on the safety of U.S. debt.

“The surprise to me is that the markets paid as much attention to S&P as they have,” Krueger said. “S&P has no private information, and their track record and judgment have been dismal.”

S&P was too influenced by Wall Street, had insufficient resources and used outdated models to grade mortgage securities that blew up when the U.S. housing market collapsed in 2007, the Senate Permanent Subcommittee on Investigations said in an April 2010 report.

“Clearly, the U.S. fiscal situation is unsustainable unless a large, multiyear fiscal tightening is implemented,” economists at Goldman Sachs Group Inc., including Jan Hatzius, said in a research note. “However, there is no information in today’s report about the fiscal situation that was not already known. Academic research has generally found that rating-agency actions lag market pricing, rather than lead it.”

To contact the reporters on this story: Rebecca Christie in Washington at rchristie4@bloomberg.net; Ian Katz in Washington at ikatz2@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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