Standard & Poor's Corp., one of Wall Street's top ratings agencies, put the United States on notice Monday that it may lose its gold-plated AAA rating if it does not act quickly to pare down deficits ranging over $1 trillion for years to come.
Although Congress and President Obama have offered proposals to slash about $4 trillion from future deficits, S&P said those plans are far apart on how to achieve the budget reductions, and resolution of the differences may not occur until after the 2012 presidential election — not soon enough to prevent a downgrade.
"Looking at the gulf between the parties, it has never been wider than now," said David Beers, managing director at S&P, noting that Republicans and Democrats are nowhere near agreement on whether to raise taxes or what to do to reform Medicare and Medicaid.
"It takes a lot of political will to bridge this gulf," he said, and the ratings agency thinks there's a one-in-three chance it won't happen, and the U.S. will lose its top credit rating in the next two years.
A downgrade of the United States — the first in the 236-year history of the country — could have dire consequences for the nation, for Congress and for financial markets all over the world.
It would cause the interest rates that the U.S. Treasury must pay on the $14 trillion national debt to rise — possibly sharply — making it even harder to cut the deficit and possibly creating a "debt trap" where it becomes impossible to keep up with increases in the debt caused by rising interest rates. That is what has led to the downfall of Greece, Ireland and Portugal.
At a minimum, the Treasury would no longer have access to the cheap financing that has made it possible for the country to go deeply into debt to finance two wars in the past decade, offer generous aid to cushion the impact of the recession and pay for the steadily increasing burden of a retiring population.
The U.S. and its dollar also might lose their status as the premier safe havens for the world's investors, one of the major reasons the U.S. has been able to finance huge debt burdens so easily while other nations with similar debt loads fell into financial crisis.
Mr. Beers said the behavior of U.S. political leaders has not compared favorably with those of other nations that have AAA status, and that was a key factor in the agency's decision to put the U.S. on review for a possible downgrade.
Other AAA-rated nations like Germany, France and the United Kingdom also have big debt burdens, but they started tackling their debt problems a year ago while the U.S. has only added to its debt with more tax cuts and spending programs, he noted.
The Conservative government in Britain, for example, has imposed a draconian mixture of spending cuts and tax increases to prevent its debt from getting out of control, he said, while the U.S. has only in the past few weeks even begun to discuss the possibility of such measures.
"In all these cases [in Europe], the governments are clearly on the path to bringing the deficits down. The United States is not," Mr. Beers said.
The shock of S&P's move and the dark outlook it portended for financial markets sent stocks plummeting on Wall Street Monday, with the Dow Jones Industrial Average falling more than 250 points before cutting losses to end down 140.
The White House protested S&P's move at the same time it sought to show that the Wall Street firm's doubts that President Obama and congressional leaders will forge a major budget-cutting deal before the presidential election are ill-founded.
Austan Goolsbee, chairman of the Council of Economic Advisers, called it a "political judgment" that "we don't agree with" in an interview on CNBC.
Treasury Secretary Timothy F. Geithner pointed out that Mr. Obama last week started bipartisan talks aimed at forging a budget deal, and said it's not too late to preserve the country's top credit rating.
"Both political parties now agree that it is time to begin bringing down deficits," he said. "We believe S&P's negative outlook underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation."
The White House noted that S&P's competitor, Moody's Investors Service, viewed recent developments differently.
Moody's said Monday that the recent submission of plans by both parties to cut deficits by $4 trillion over the next 10 years was a sign that at least basic agreement has been reached on the "parameters of the debate."
Moreover, that could be viewed as "a turning point that is positive" for the U.S. credit rating, said Moody's, which also rates the U.S. as AAA — the highest possible grade for a country's debt.
Republican congressional leaders said S&P's warning is a "wake-up" call that validates their plans to use the upcoming vote on a measure increasing the nation's debt limit as a vehicle for enacting major spending cuts and budget reforms.
"Today’s announcement 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," said House Majority Leader Eric Cantor, Virginia Republican.
Other legislators stressed the urgency of working on a plan that both parties can endorse.
"The stakes are high" for political leaders striving to reach a bipartisan deal behind the scenes, said Steve Bell of the Bipartisan Policy Center.
While S&P's warning was a jolt for financial markets and "raises the stakes" for Congress, Nigel Gault, economist at IHS Global Insight, said he does not entirely agree with the credit agency's conclusions.
"Just how much time the United States has before it must act is open to debate," he said. "We would argue that the prospects for long-term deficit reduction have actually improved over the past few months."
Not only have both the U.S. House and Mr. Obama offered proposals to cut $4 trillion out of future deficits, but Congress is moving toward major curbs in spending without being forced to take action under market pressure, he said.
Mr. Gault credited the Republican-led House with forcing this year's debate over dealing with the deficit.
The interest rates on Treasury debt — surprisingly — barely budged in response to S&P's announcement, and they remain historically low, he noted.
That means that Congress and the president may have time to wait until after the 2012 presidential election to enact a major budget deal. But he said the new Congress and administration would have to act almost immediately in January 2013 to avoid a loss of confidence in financial markets.
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