The American Debt: S&P Paints a (Grotesque) Picture

By Eliza

Jul 22, 2011 11:29am

gty money hundreds jef 110412 wmain The American Debt: S&P Paints a (Grotesque) Picture

ABC News' Dan Arnall (@abcmoneyguy) reports:

Credit rating agency Standard & Poor’s issued a report Thursday outlining what it expects might happen in the coming weeks as Congress and the Administration struggle with the hard work of the debt limit and a deficit reduction plan.

“In our view, the need for an agreement to raise the debt ceiling before it is breached–which the government has said would occur on or around Aug. 2–remains a major risk to the U.S. economy, in our view,” says the report. “Because we see a real risk that efforts to reduce future deficits may meaningfully miss the targets that Congressional leaders and the White House have discussed, we put the likelihood that we would lower the long-term rating on the U.S. within the next three months and potentially as soon as early August–by one or more notches, into the 'AA' category–at about 50-50.”

The report jumps in with explorations of three scenarios:

  1. THE GOOD (Raise the Limit; Credible Deficit Reduction):  “If the opposing camps agree to raise the debt ceiling before the deadline and come to terms on a long-term debt-reduction plan, Standard & Poor's would likely affirm the U.S. ratings and remove them from CreditWatch. It is possible, however, that the rating outlook could remain negative while we evaluate the likelihood that an agreed plan will be implemented.”
  2. THE BAD (Raise the Limit; No Credible Deficit Reduction): “Under this scenario, we might lower the U.S. sovereign rating [one or two notches] with a negative outlook within three months and potentially as soon as early August. … We assume that under this scenario we would see a moderate rise in long-term interest rates (25-50 basis points), despite an accommodative Fed, due to an ebbing of market confidence, as well as some slowing of economic growth (25-50 basis points on GDP growth) amid an increase in consumer and business caution.”
  3. THE UGLY: (Don’t Raise the Limit; No Deficit Reduction and a Technical Default in August): “… while we think this possibility is the least likely, we find it difficult to disagree that it would wrack global financial markets and likely shove the U.S. economy back into recession.”
    1. Interest rates rise; markets start to drop and the dollar loses value
    2. “We think it possible that the Treasury could successfully roll over the $59 billion in maturities due on Aug. 4 and Aug. 11, and could make the Aug. 3 Social Security payments, while sharply cutting discretionary spending and delaying payments to state governments, vendors and contractors, and federal employees.”
    3. By August 15 when the government has $62 billion in interest payments due, S&P envisions an actual default (we don’t pay the interest due to the holders of the Treasuries)
    4. “Even if the Fed and other central banks managed to keep the financial system functioning, we expect that markets around the world would be severely damaged. In such a hypothetical scenario, we expect that equity markets would generally plunge, borrowing costs and interbank lending rates would soar, and corporate credit markets would be closed to all but the highest quality issuers. We envisage that consumers and businesses would likely stop spending on all but essential items, and the value of the dollar would drop by 10% or more against other major currencies. With the dollar heading lower, investors would likely look for hard assets like oil and other commodities, driving prices higher.”

If you want to get really worried – read the full hypothetical for Scenario 3. After laying out the bloody details, the analysts the go on to outline what a default might mean to various parts of the global economy.

Bummer, right? Well, they do end on a high note, offering up some hope that the worst case isn’t the most likely case.

“Collaboration on substantial spending cuts appears to be within reach, though we see demands that spending be trimmed by as much as the increase in the debt limit as a potential stumbling block. Still, we expect that cooler heads will prevail in the end, and Washington will avert a default. The consequences of not doing so would simply be too severe, in our view.”

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