Fitch to U.S.: This Is No Way to Run AAA Country
One week ago, when it looked as if a deal to reopen the U.S. government and raise the debt ceiling was at hand, financial markets were ecstatic. The Dow Jones Industrial Average had its best day in nine months, rising 323 points, or 2.2 percent. Why the euphoria?
The quick answer is, anything that reduces the risk of default is a big plus. Most analysts, including those at the credit-rating companies, expect the Treasury to make timely payments of principal and interest because the consequences of a default would be so dire. And only a handful of individuals -- mostly Republicans in the House of Representatives -- seem willing to test the government’s claim that it has no ability to prioritize debt over nondebt payments.
I’m at a loss to come up with a more convincing reason for the reaction to the latest let’s-make-a-deal effort. There was nothing in last week’s proposals, or in the deal du jour, to inspire confidence, unless your thinking is strictly short-term -- one thing politicians and markets have in common.
The Senate measure negotiated this week by Majority Leader Harry Reid and Minority Leader Mitch McConnell, which produced an agreement today, includes a provision for a bicameral conference committee, and a Dec. 13 deadline to come up with long-term budget solutions. Good thing the leaders aren’t calling the conference a “supercommittee.” We know how that worked out last time: Congress managed, by default, to tackle a nonproblem with a blunt instrument -- across-the-board cuts to discretionary spending -- that everyone hates. Touche!
What Congress “fixed” is the share of the budget that is subject to annual congressional appropriations. Thanks to sequestration and budget caps, discretionary spending is set to decline for the third consecutive year in fiscal 2014, the first time that’s happened in at least 50 years. In its long-term budget outlook last month, the Congressional Budget Office said that spending on everything other than the major health-care programs, Social Security and net interest payments will shrink to 7 percent of gross domestic product by 2038, less than the 40-year average of 11 percent and the smallest share since the late 1930s. It’s the part of the budget on automatic pilot -- outlays for programs such as Medicare and Social Security, as well as interest on the debt -- that needs some restraint.
Although there are good reasons to be suspicious of long-term budget projections, in this case, the demographics say it all. There are fewer young people working to support a growing number of retirees. The short-term cyclical improvement in the deficit in the current decade will give way to two lines -- federal spending and revenue -- growing farther apart. This is our future, as summarized by the CBO: Under current law, federal debt held by the public will reach 100 percent of GDP by 2038, the largest share since 1946. “With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable,” the budget office said.
That assessment doesn’t include the adverse affects such huge debt would have on economic growth.
The dysfunction in Washington prompted a warning from Fitch Ratings this week. Fitch put the U.S.’s AAA credit rating on a negative watch, which means an increased likelihood of a downgrade in the next three to six months. (The outlook for the next 12 months was already negative.) Fitch cited “political brinkmanship and reduced financing flexibility” as increasing the risk of a default.
It was during the 2011 debt-limit showdown that Standard & Poor’s Ratings Services downgraded the U.S.’s long-term credit rating to AA+, its second-highest level, from AAA. In June, S&P revised its outlook on the U.S. to stable from negative. That change was based on a reduction in the deficit-to-GDP ratio to half its 2011 level and additional declines projected for the next two years. S&P also factored in a stronger economic recovery and the government’s ability to “negotiate a compromise” that diminished the impact of the fiscal cliff.
I doubt S&P would have that same confidence today. In a Sept. 30 report on the implications of the debt-ceiling debate for the U.S. sovereign credit rating, S&P said that if the current impasse over funding the government and extending its borrowing authority is short-lived, it wouldn’t affect the rating. “This sort of political brinkmanship is the dominant reason the rating is no longer ‘AAA,’” S&P said.
The ratings companies aren’t playing politics. What they’re saying is that politics has the power to tarnish the full faith and credit of the U.S. and, as such, is an added risk factor.
If Congress raises the debt ceiling and restores the federal government to working order, the U.S.’s credit rating and outlook may rally in the short run, like the stock market. It will take more than another missed deadline and round of brinkmanship to resolve the nation’s long-term fiscal problems, which put even S&P’s AA+ rating in jeopardy.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist.)
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