Why America's Credit Rating Could Fall Again

The rating agencies have explained what would trigger a downgrade. Will Congress listen?

By + More

Members of Congress seem oblivious to their dismal approval rating and the general disgust voters have been expressing since this past summer's debt-ceiling smackdown. But legislators might want to start paying attention when certain critics express concern over their behavior.

[See 12 ways to thrive in a stagnant economy.]

On July 14, for instance, Standard & Poor's said there was a "substantial likelihood" it would cut America's AAA credit rating within 90 days if negotiators failed to reduce the national debt by $4 trillion or so. The debt-reduction plan that followed hacked only about $900 billion off the debt, with another $1.5 trillion in cuts to be determined by a new Congressional "supercommittee." Since the whole deal fell far below the target set by S&P and many other debt watchers, S&P did what it said it would do, and cut the nation's AAA rating to AA+, the first such downgrade in history. The stock market, startled by the fiasco, fell nearly 7 percent the first day after the downgrade was announced.

Now, it may happen again. The 12-person supercommittee that's negotiating in secret doesn't have to reveal its plan until the end of November. But rancorous rumblings from several members have already produced expectations of failure. "The 'not-so-super' deficit commission is very unlikely to come up with a credible deficit-reduction plan," Bank of America Merrill Lynch warned in a recent note to clients. Failure, B of A says, could trigger another credit downgrade and drag down the already weak economy even more.

One reason expectations for the supercommittee are so low is that all six Republicans on the panel have signed tax activist Grover Norquist's pledge

to oppose any increase in business or personal income taxes. And the six Democrats on the panel are unlikely to agree to big cuts in entitlement spending if tax hikes are impermissible. Last year, the well-regarded Bowles-Simpson debt-cutting panel called for a mix of about one third tax increases and two thirds spending cuts to pay down the debt. Other proposals have called for more of a 50-50 mix. What's clear to most economists is that some mix of tax increases and spending cuts is the only way to solve the problem, because spending cuts alone would decimate popular programs like Medicare and Social Security. So if tax cuts are off the table, it's hard to see how the supercommittee could reach any kind of compromise.

[See 11 things wrong with Congress.]

For the big rating agencies that grade the quality of sovereign debt, the outcome of the supercommittee's work could be a pivotal moment. Here's where they stand on the U.S. credit rating:

Standard & Poor's, which now gives the United States its second-highest rating, still has a "negative watch" on U.S. debt, which means its rating could be lowered in the future. In its latest public assessment, S&P said the odds of another downgrade within two years are at least 1 in 3. Key events that could push the odds higher or lower include the outcome of the supercommittee's deliberations, plus anything unanticipated, such as new stimulus spending, that would add to the national debt.

Moody's has retained its triple-A rating for the United States (which it styles Aaa), but has also indicated that a future downgrade is possible. It lists four possible reasons a downgrade could happen: backsliding on spending cuts already in place; a lack of additional measures to address the debt; a weaker economy than expected; and higher-than-expected borrowing costs for the U.S. government. The last of those four conditions seems unlikely in the near future, but the first three are possible, if not probable.

[See how politicians are wrecking the economy.]

Fitch Ratings, like Moody's, continues to rate U.S. debt AAA. But it, too, sees trouble ahead. "The failure of the [supercommittee] to reach agreement on at least $1.2 trillion of deficit-reduction measures could trigger a negative rating action," Fitch said in a recent report. Fitch also says that a weaker-than-expected economy could lead to a downgrade.

That leaves all three major rating agencies stating fairly clearly that the supercommittee has to cut the debt by at least $1.2 trillion, and preferably more, just to keep America's credit rating where it is. Debt reduction of that magnitude will require big decisions on the most controversial issues: Whether to raise taxes, cut Medicare and Social Security spending, and slash defense spending. It's possible Congress could do it, and the Bowles-Simpson commission laid out a blueprint that needs only to be acted upon. But the toughest decisions are the ones that will roil voters the most, and with elections coming up, Congress watchers are doubtful.

If the supercommitte punts, across-the-board spending cuts totaling $1.2 trillion will kick in. While this would come close to the total amount of additional cuts the debt deal called for, it would be a chaotic and inefficient way to accomplish the goal. Immediate cuts would reduce GDP, which could produce the weaker economy Moody's and Fitch are worried about. It would also represent an abdication of Congress's most basic responsibility—controlling the nation's purse strings—and signal that Washington is nearly incapable of solving problems of its own creation. "We view the fiscal policy debate as revealing a low willingness to compromise and a disturbingly high willingness to risk potentially significant consequences for financial markets and the economy," Moody's said in a recent report. A less judicious way of saying that might be: Washington is wrecking the economy.

[See who would win under Obama's jobs plan.]

Bank of America Merrill Lynch predicts that another downgrade would send stock markets and general confidence levels down again, though not by as much as the 7 percent drop in August. At some point, a lower credit rating could force the Treasury Department to pay higher rates to borrow, which would make the whole problem worse. Meanwhile, America's creditworthiness would emphatically fall below that of Canada, France, Germany, the U.K., Australia, Singapore, and a dozen other top-rated nations. The United States would join the ranks of Japan, Qatar, China, and Belgium as an AA risk. Not exceptional, but not bad. Perhaps we should just get used to mediocrity.

Twitter: @rickjnewman

  • Ten ways the economy would change under Romney.
  • How Perry and Huntsman beat Romney on jobs.
  • Why the Wall Street protests are going mainstream.