U.S. Debt Rating Called into Question

On Friday, April 15, the U.S. Government had debt outstanding of $14.268 trillion, equal to roughly 95.5% of the nation's gross domestic product. See this graph of the debt as a ratio to GDP to see how it has leaped over just the last three years.

For years, the debt of the U.S. Government has held status as the virtual definition of a safe haven in the world's financial markets. Our national government has the highest level "AAA" credit ratings from the two well-known and respected credit analysis companies, Moody's and Standard & Poor's (S&P). This has been such a firm standard that the values for many other U.S. and world debt-market assets are frequently quoted not in terms of their own interest rate or a price per se, but by the spread between their interest rate and the going rate on U.S. Government bonds or notes. U.S. issues have thus been the benchmark for valuing nearly all other debt, both in this country and elsewhere.

Such a strong position suggests that the U.S. Government has been perceived as the most rigorous in establishing and enforcing its own spending and taxing rules and that those policies engender a healthy economy largely free of disabling distortions. That is, the prestigious position of our debt in the world carries with it a significant responsibility for – we won't apologize for our words here – being adult in our budget and financing practices.

11th Hour Fiscal Policy Action
What we have seen, though, over the last year, has been disregard of these standards by our fiscal policymakers even as deficits and consequent debt have been enormous. In three separate situations, they have skirted definitive, decisive actions to bring these conditions under control. Both Democrats and Republicans have contributed to the disorderly environment. First, for the current fiscal year 2011, spending authorizations that should have been enacted by Congress before the year began on October 1 were just handled ten days ago and only then, in the face of a threat that government operations would shut down due to lack of legal authority to spend money. This was saved by a literal 11th-hour, 11:00PM agreement on the night the latest temporary spending resolution was due to expire. No one was really satisfied by the terms of the final agreement, but at least there was no disruption of ordinary government services.

Secondly, concerning the upcoming fiscal year 2012 budget, the President, to his credit, had started on the right foot. He nominated a bi-partisan commission to study and advise him on ways to get spending and the deficit under control; they reported in November and December. But in February, when he presented his own budget for fiscal 2012, he basically ignored their recommendations in a plan that proposed little action toward improving the long-term budget outlook. House Republicans recently presented a plan of their own, but the President's immediate reaction to their concrete proposal was an attack[1], rather than an outreach toward negotiation that might lead to mutually acceptable principles for budget and debt reform.

Debt, Too, Nears a "Deadline"

Now, thirdly, there is also argument over raising the debt ceiling. The Treasury estimates that the debt will reach the statutory $14.294 trillion limit by about May 16. We have experienced such debt ceiling limitations before. Since the legislation to raise the ceiling must be acted upon for the Treasury to be able to borrow more money, Members of Congress traditionally demand that some personally desirable programs or favors be incorporated into the bill. This time, some prominent Republicans have stated that they oppose raising the limit at all. This stance to disallow any increase in the debt at all is hardly realistic when there is a concurrent deficit in the balance of spending and receipts. Theirs is obviously a negotiating position, but it seems ill-advised with such large numbers and such an obvious disagreement on the conditions anyone might demand in order to acquiesce in an increase.

For their part, Administration officials have irresponsibly raised a spectre of credit default if the debt ceiling is reached. In fact, there would not be any outright default. Maturing bonds could be re-financed and current inflows of revenue would more than cover interest expenses. Spending would, to be sure, be constrained to the amount of receipts since there could be no new debt, and there would certainly be disruptions in programs. But that is not a "default" in which existing debtholders go unpaid. Some other countries do face that prospect and it is reckless to express our situation in the same terms. Further, since, as we pointed out, there is probably less than a month before the current ceiling is reached, it's unnerving that with this looming, Congress has taken off on its traditional two-week Easter recess, and the Senate Majority Leader and the Speaker of the House are both out of the country. [They're in China and Pakistan, respectively, so they're hardly on pleasure kicks, but being at home working on our primary national priority might be the better use of their time just now.]

A Red Flag on our Credit Rating
So in the midst of all this, yesterday morning, Monday, April 18, just before the stock market opened for trading, Standard & Poor's woke us all up to the seriousness of the dilly-dallying on our budget situation in the face of the current massive deficits and rapidly increasing debt load. Issuing an official statement[2], they said that, while they affirm our AAA rating, they have changed their expectations for that rating going forward from "stable" to "negative". S&P initiated the "negative outlook" designation in 1989 and this is the first time they have applied it to the U.S. Government. The S&P analysts assess that there is a one-in-three chance that the rating could be cut sometime over the next two years. They anticipate, they wrote, that the current political posturing means the issue won't receive serious action until after the 2012 elections, and they fear the added cost of the deficits and debt that will pile up in the meantime. We would no longer have fiscal relationships in our economy that are as good as, much less better than, other AAA-rated countries, S&P explains. Other countries, especially the U.K. and France, have already enacted budget reform programs and are implementing those. We can't even talk to each other yet.

We have written here several times before about several fiscal policy needs: rationalizing social security, consciously discussing and choosing among the tasks and missions we want the federal government to fulfill, reducing wasteful spending. This week in particular, having just filed 2010 tax returns, we could also mention simplifying the tax code. While one sees that an election campaign might stimulate the national conversation that would facilitate these decisions by our elected officials, S&P believes there has already been ample opportunity for this, and, since we've already said so here, we would endorse their argument. One can always find some reason to postpone difficult decision-making. But the issues themselves will continue to fester. Several of our economist colleagues actually thanked S&P yesterday for calling out our politicians and asking them to practice statemanship. That is surely what is needed. We hope they rise to the occasion.
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[1]The President spoke at George Washington University on April 13 in what had been expected to be a major fiscal policy statement. Unfortunately, he took a harshly negative tone commenting on the Republican proposal, so that his approach came across as combative, not collaborative.

[2]Here's the Standard & Poor's statement. http://www2.standardandpoors.com/spf/pdf/events/UnitedStatesofAmericaRatingAffirmedOutlookRevisedToNegative.pdf