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Debt fight poses new risk to U.S. credit rating
S&P warns of 2nd downgrade
Question of the Day
Moody’s says it will evaluate the U.S. rating in light of what happens in the elections and months afterward. But it was troubled by a Social Security trustees report this spring showing that projected outlays for the retirement program will nearly double to $927 billion in the next decade because of earlier-than-expected baby boomer retirements and growing disability claims.
The unexpected surge in spending, which many economists attribute to layoffs during the recession that pushed many baby boomers to apply for early retirement and disability benefits, means the program from this point on will spend more than it takes in in payroll taxes, and will fall into insolvency three years earlier, in 2033, Moody’s noted.
“The projected cost increase is credit negative for the federal government,” said Moody’s Vice President Steven Hess. Moody’s has indicated that it might downgrade the U.S. if Congress and the president do not enact a major deficit-reduction deal addressing the need for entitlement reforms after the elections.
Any downgrade by Moody’s could be more devastating than a second downgrade by S&P, analysts say, because it would clearly move the U.S. out of the exclusive club of AAA-rated nations and throw into question the privileged status of U.S. Treasury securities as a safe haven for global investors.
Threat to Treasury
Any significant flight from the Treasury market triggered by a downgrade would raise Treasury bond rates and have devastating consequences. The Congressional Budget Office has estimated that a 1-percentage-point increase in rates would increase Treasury’s debt payments by $1 trillion in the next decade, wiping out the benefit of all the budget cuts enacted by Congress last year.
Treasury’s safe-haven status is the critical factor that enabled the U.S. to avoid a debilitating increase in interest rates after the S&P downgrade last year, said Ivan Rudolph-Shabinsky, an analyst at AllianceBernstein.
In fact, Treasury rates declined after the S&P downgrade as the U.S. benefited from the turmoil created by the European debt crisis. The flight to safety by investors drawing out of Europe has pushed Treasury rates to record lows, with the yield on Treasury’s 10-year bond falling for the first time to 1.44 percent.
Those extraordinarily low interest rates not only have enabled the U.S. government to easily finance its growing debt load, but have been a boon to the beleaguered U.S. housing market and indebted U.S. consumers.
Thirty-year mortgage rates, which are linked to the 10-year bond rate, have plunged to record lows, below 4 percent, triggering a big wave of refinancings and boosting prospects for a budding housing recovery.
Mr. Rudolph-Shabinsky said America’s safe-haven status doesn’t appear to be in much danger, but how markets view the political impasse will be critical.
“The current assumption is that the threat of a potential crisis will spur the U.S. government to act” to reduce the debt at the end of the year, he said. But what if global investors conclude, like S&P, that “the U.S. is simply incapable of addressing its underlying structural issues with Social Security, Medicare and other entitlement programs?”
In that case, Treasury yields will rise and “higher financing costs will cause a dramatic deterioration” in U.S. finances, he said, possibly putting the U.S. in the same boat with Greece, Spain and other debt-strapped European countries.
“The U.S. might fall into the category of sovereign downgrades that accelerate an already-worsening fiscal situation,” he said.
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