It could be a long hot summer as voters wait for an agreement on taxes and spending programs in the U.S. that expire at year's end — a repeat of last summer's debt-ceiling debate. In fact, uncertainty over that and a debt crisis in Europe have been hammering the markets. So I caught up with CEO Sean Egan of ratings agency Egan-Jones, which was first to cut the U.S. debt rating last year, to get his take on the implications. The interview is edited for clarity and length.
Q: Headlines coming out of Europe are driving the markets here.What are the biggest problems in the eurozone?
A: The largest problem, and it's a very difficult problem to solve, is that debt relative to GDP has continued to increase for most European countries.
Q: How did this debt get accumulated? Why are these countries in such debt?
A: They're not that dissimilar to the U.S. They've been spending a lot more money than they've been taking in. With the decline in the GDP, the assumptions that were made in setting the budgets have not been met, so the deficits continue to build.
Q: If you look at a country like Spain, where the unemployment rate is 24%, is austerity the answer right now, given the fact that you've got such steep unemployment? Or will that worsen the situation over the near term?
A: You have Depression-level unemployment. At a certain point, the attempts at austerity are counterproductive and you're seeing that in a number of countries. In the case of Greece, taxes can be increased to 100% of one's income, theoretically, but you're unlikely to collect additional taxes because the citizens are not willing to pay the additional amounts.
Q: So what is the answer? Stimulus or austerity?
A: We don't think that austerity works. As far as stimulus, our view is that that doesn't work, either, for the simple reason that it often just increases debt without a similar increase in GDP. We think that with debt-to-GDP for the total of the eurozone near 100%, there has to be a cutting of the debt, unfortunately. Countries simply don't have the ability to repay the debt on time. And you're seeing increased concerns being reflected in the rise in funding costs, particularly in Spain and in Italy, where rates have exceeded 7% within the past 10 days.
Q: So as rates keep moving higher, 7% and 8% for Spain and other countries, it gets harder for these countries to pay their bills. How do you break that cycle?
A: It becomes harder and harder to break. I use the metaphor of a black hole. As conditions worsen, it gets harder to escape the pull. Ultimately, there's going to have to be a reset, a restructuring of the debt.
Q: We have heard a lot about Greece, Ireland, Portugal. And Spain keeps coming up. Which is most problematic?
A: Greece is in the forefront for requiring another restructuring. I've said that Greece would have to default and that the ultimate recoveries were going to be between 5% and 10%. Greece is probably in the forefront for having another major restructuring. Spain and Italy are actually in a race, unfortunately.
Q: Spain and Italy are the third- and fourth-largest economies (in the eurozone).