U.S. Debt Rating: Economists Wait to Hear From S&P

Economists Debate if S&P Will Downgrade the U.S.

BySusanna Kim
August 02, 2011, 10:40 AM

Aug. 3, 2011 — -- Now that President Obama has signed the debt ceiling deal and averted a default, economists are waiting to see if ratings agency Standard and Poor's will downgrade the nation's credit rating.

The uncertainty surrounding the US's now-perfect AAA rating has also thrust the three major ratings agencies into the spotlight, raising questions about the significance and boundaries of their credit assessments.

Moody's Investors Service on Tuesday evening affirmed its AAA U.S. government bond rating, though it lowered its outlook to negative.

"The initial increase of the debt limit by $900 billion and the commitment to raise it by a further $1.2-$1.5 trillion by year's end have virtually eliminated the risk of such a default, prompting the confirmation of the rating at Aaa," Moody's stated in a report.

At stake in all this is not only interest rates the US must pay on its $14.4 trillion debt, but a host of rates for consumers, from mortgages to car loans to credit cards. A downgrade of US debt would cause interest rates of all kinds to edge up and that would cost the US and consumers billions of dollars. The stock market plunged yesterday partly on worries about this possibility.

Moody's assigned a negative outlook to its rating, saying it could downgrade the US if fiscal discipline weakens in the coming year, further "fiscal consolidation" does not take place in 2013, the economic outlook "deteriorates significantly," or there is an appreciable rise in the government's spending "over and above what is currently expected."

Earlier on Tuesday, Fitch Ratings released a statement confirming its AAA rating for the U.S. over the short-term. But Fitch's report said the country must make "tough choices on tax and spending" over the medium term and it will "conclude its scheduled review of the U.S. sovereign rating by the end of August."

Now the only holdout is S&P, which warned last month that the U.S. risked a downgrade to AA status if Congress did not lift the debt ceiling and reduce the total debt by $4 trillion over the next decade.

Ethan Harris, Bank of America Merrill Lynch economist for North America, said he expects S&P to downgrade the U.S. rating in the near future to AA.

"The downgrade is a close call, but still it seems likely," Harris told ABC News. "The S&P has said it wants to see clear signs that the US is moving onto a sustainable debt path. That means stabilizing debt as a share of GDP. The likely $2.1 trillion in cuts in the current legislation falls well short of the $3 to $4 trillion needed to stabilize the ratio."

But Peter Hooper, chief economist with Deutsche Bank Securities, said the likelihood of a downgrade in the next few months is "still low."

"The fact the deal passed with a comfortable majority and fairly strong bipartisan support includes a significant step in the right direction though a lot more needs to be done," Hooper told ABC News. "The ratings agencies may be encouraged by the progress made, but they want to see how this deal plays out and how the joint select committee operates."

On top of the $1.2 trillion in spending cuts the Senate and House approved, a "super committee" must make an additional $1.5 trillion in spending cuts between 2012 and 2021, according to the Congressional Budget Office.

Ed Kashmarek, economist with Wells Fargo, said it is unclear why the ratings agencies have become more vocal, or perhaps just received more publicity, in the past year when the U.S. has struggled with its debt for some time.

"For S&P to say it wants to downgrade our debt rating if we don't cut $4 trillion, where was that demand a year ago?" Kashmarek said. "Is it because of we have a near 100 percent total debt to GDP ratio. Is it for political reasons? It's hard to say."

Jim Nadler, president of Kroll Bond Ratings, said his one-year old company is trying to break the "oligarchy" comprised of Moody's, Fitch and S&P. He said the agencies have overstepped appropriate lines by becoming too involved in policy making instead of sticking to ratings.

"As they became more high profile, it appears as though they have become more involved or more interested in the politics of budgets, revenue and things like that instead of a bystander," Nadler told ABC News. "I think once you inject yourself you begin to lose your independence."

Legislators have questioned the ratings agencies' responsibility in the financial meltdown for giving high ratings to risky mortgage-backed securities and collateralized debt obligations.

On July 27, a House oversight subcommittee on financial services held a hearing questioning executives of Moody's and S&P, including S&P president, Deven Sharma.

"We at S&P certainly share the goal of enhancing the transparency, integrity and qualityof ratings and the ratings process," Sharma said in his prepared remarks. "We also firmly believe that perhaps the most important value of ratings is their independence."

This week, the Associated Press reported Moody's, Fitch Ratings and S&P and its parent company, McGraw-Hill, have spent $1.76 million total this year to lobby Congress and federal agencies for a range of issues.

"Fitch sometimes utilizes lobbyists, but such corporate matters are completely separate from and have zero influence upon our analytical groups that assign ratings," Daniel J. Noonan, corporate communications managing director of Fitch Ratings, said.

McGraw-Hill also points out that the company's interactions with lawmakers include answering questions, on a range of topics including those related to its educational publishing business.

"Our analysts convey independent opinions about creditworthiness to the market using rigorous analytical criteria," Patti Röckenwagner, marketing and communications senior vice president of The McGraw-Hill Companies, told ABC News. "Our lobbyists express views about public policy to the government. There is a strict firewall that separates the two --- always has been, always will be."

Phillip Swagel, former assistant secretary for economic policy at the Treasury Department from 2006 to 2009 and former chief of staff at the White House Council of Economic Advisers, said there is no evidence the rating agencies' regulatory comments are related to their views on sovereign credit.

"Every firm, including the rating agencies, has a right and a responsibility to comment on the many regulatory decisions under Dodd-Frank -- the agencies would be remiss if they did not comment," Swagel told ABC News. "And in any case, they agree with the regulators that their ratings should not be embedded into official decisions."

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