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Credit agencies warn about debt-payment delay
Inaction could trigger drop in rating
With signs multiplying that debt-reduction talks between the White House and Congress are at an impasse, Wall Street credit agencies are stepping up their warnings that even a temporary delay in making payment on the government's $14.3 trillion of debt will result in a significant cut in the nation's perfect credit rating.
In unusually frank statements about the consequences of congressional inaction last week, Moody's Investors Service said it anticipates a cut from AAA to AA if the impasse leads to even a brief suspension of debt payments after the Treasury effectively reaches its borrowing limit Aug. 2. And Standard & Poor's warned that it would go further and plunge the U.S. rating to the lowest possible rung — a "D" for default.
"If any government doesn't pay its debt on time, the rating of that government goes to D," said John Chambers, managing director of sovereign ratings at S&P, in an interview with Bloomberg Television.
But he quickly added that because of that very real consequence of default, among others, he expects the dramatics and disagreements over the debt limit will ultimately be resolved in time and that Congress will once again raise the nation's borrowing limit as it has 78 times before since 1960 — "often at the last minute."
A junk rating of D would make it impossible for the U.S. to finance its debt, much less add more on top of it, since the world's major pension and investments funds generally are not allowed to invest in debt rated that low. Few other funds — even China's vaulted $3 trillion of foreign-exchange reserves — have enough money to absorb the mammoth amounts of debt issued by the U.S.
But even a lesser cut in the credit rating such as that envisioned by Moody's would force the government to pay higher interest rates on Treasury bonds and notes.
Currently, the U.S. pays an extremely low 3 percent rate on average on its debt. At the current rate of borrowing, the nearly $200 billion tab in interest paid by taxpayers this year is due to rise to nearly $500 billion within four years — assuming the U.S. keeps its AAA credit rating, according to the Congressional Budget Office. The tab would be substantially higher if rates go higher.
As Treasury rates rise, so would the rates on nearly every other kind of U.S. loan, including most mortgages, credit cards, consumer and business loans, whose rates typically are linked to Treasuries. Economists say such an across-the-board shock in borrowing rates has the potential to derail a fragile recovery that has failed to take off this year even with record-low interest rates.
Beth Ann Bovino, S&P economist, said she expects interest rates to rise by nearly a full percentage point by the end of 2012 just based on the onslaught of borrowing scheduled by Treasury in the next year, even if it maintains its top credit rating.
"But if Congress cannot reach an agreement on how to manage the debt, the results would be disastrous worldwide," she said, with the possibility of a debt crisis breaking out in the U.S. like the one in Europe that has sent interest rates in the most heavily indebted countries to double-digit levels.
"Interest rates would jump for new bonds, as they have in Greece, Portugal and other heavily indebted nations," she said. "An increase in rates would put a halt to the fragile recovery by choking off credit to businesses and households."
In holding out the threat of an imminent and potentially devastating downgrade, some critics say the ratings agencies may be trying to get even with U.S. legislators who severely criticized them for failing to warn investors about the dangers of subprime mortgage securities before a crisis broke out in 2007 and 2008.
Federal authorities have been investigating whether their failure to act at that time constituted civil fraud.
But other financial experts say the ratings agencies have been too slow to warn of the dangers of debt and deficits in the U.S. that, as a percentage over the overall economy, currently rival the size of the most troubled countries in Europe. In fact, less well-known credit agencies in China and Germany already have lowered their ratings on Treasury debt, and Florida-based Weiss Ratings gives Treasury only a middling C grade.
Weiss says it didn't give the U.S. a lower rating, despite its poor management of deficits and debt in recent years, because of two offsetting strengths: its large and strong economy, and the reserve currency status of the U.S. dollar, which enables the country to borrow more than other countries at lower interest rates.
Independent experts ranging from Federal Reserve Chairman Ben S. Bernanke to former Fed Chairman Alan Greenspan and the International Monetary Fund also have raised dire scenarios about a debt crisis that could be only a month away, given the current impasse.
According to Treasury's calculations, Congress must have passed an increase in borrowing authority by Aug. 2 to avoid the possibility of default. But because of the many conditions that Republican legislators are attaching to increasing the debt — generally requiring equal or greater cuts in spending and no tax increases — legislative aides said an agreement must be forged by July 22, to allow time for votes in the House and Senate and beat that deadline.
"A debt default in the U.S. government debt market would have very serious, far-reaching, dramatic repercussions, and that's why we're confident that it will be avoided," said John Lipsky, the IMF's acting managing director, on Wednesday.
But he warned against even a lesser misstep, saying that "a loss of fiscal credibility could cause an increase in interest rates or even potentially a sovereign downgrade, and that would have significant repercussions here and elsewhere."
According to the rating agencies and other Wall Street analysts, the stakes go far beyond just how easily and cheaply U.S. citizens, Congress and Treasury can borrow in the future.
They say a large swath of the U.S. economy and financial markets also would be shaken even by a relatively small downgrade of the U.S. government because it would trigger a cascade of credit downgrades on other vital institutions.
Among the pillars of the economy whose credit ratings would be threatened are numerous state and local governments, major banks, mortgage giants Fannie Mae and Freddie Mac, the Federal Home Loan Banks and Federal Farm Credit Banks. A downgrade of Fannie Mae or other mainstays in the housing and credit sectors that are still struggling from the recession could be particularly devastating, analysts say.
Moody's, which said it may move on the U.S. rating by mid-July if Congress continues to dawdle over the debt limit, is reviewing institutions throughout the U.S. economy to determine how dependent they are on funding from the federal government and thus how vulnerable they would be to a default on U.S. obligations.
"Some Aaa ratings of state and local governments could be vulnerable to credit pressure where sovereign credit linkages are potentially strong," the Wall Street agency said in a statement Wednesday. But it added that the handful of U.S. corporations, such as Exxon Mobil and Johnson & Johnson, that have earned AAA ratings on their own, not through linkages to the government, likely would be unaffected.
Some Republican legislators have argued that a default can be avoided once the Treasury hits its debt ceiling next month if the government gives top priority to paying interest on the debt and delays payment of other government obligations until the impasse is resolved.
But a study by the Bipartisan Policy Center last week said that strategy would backfire and still endanger the government's credit rating.
Treasury, which cuts about 80 million checks to pay the government's bills in a typical month, could exhaust all of the revenues it is due to receive in August by paying only six major items: interest on the existing debt, Medicare, Medicaid, Social Security, unemployment insurance and defense contracts, said the study's author, Jay Powell, a former undersecretary of the Treasury under President George H.W. Bush.
That would leave no money to fund entire U.S. departments, such as Justice, Labor and Commerce, he said, and there would be no funds to pay for veterans' benefits, IRS refunds, military active-duty pay, federal salaries and benefits, special-education programs, Pell Grants for college students, or food and rent payments for the poor.
"The choices would not be pretty," Mr. Powell said. Moreover, Treasury's ability to roll over $500 billion of securities that mature during August would be in peril, he said, likely triggering a downgrade even if Treasury strives to make all interest payments.
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