S&P to USA: Get Serious

What does it mean for S&P to have a “negative outlook” on America’s credit rating?

Dollars being printed. Click image to expand.
Printing money

Standard & Poor’s has attached a “negative” outlook to the United States’ sterling credit rating. The ratings agency did not actually downgrade America’s debt, currently rated at AAA/A-1+. Rather, it said there is a one-in-three or better chance that it will downgrade it if the United States does not get its fiscal house in order, and quick.

The news wasn’t all bad. S&P did not actually deign to change its rating. Its analysts praised the United States’ “flexible and highly diversified” economy and its “effective monetary policies.” They also noted a “consistent global preference” for the dollar over other currencies, helping to keep the government’s borrowing cheap. But, they noted the obvious: The United States has big annual deficits, $14 trillion in debt, and, to put it gently, a bonkers political system that is making it close to impossible to do the responsible thing in a timely manner. The problem is not financial, S&P argued, at least not right now. The problem is political.

“We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013,” they wrote. “If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.”

The warning shot came across loud and clear in Washington and on Wall Street. House Majority Leader Eric Cantor responded with some stern words for his colleagues: “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.” He’s being disingenuous about that “immediate” part—S&P specifically says the problem is in the medium- to long-term. He’s also being disingenuous about the “reduce federal spending” bit—S&P says it is agnostic on whether fiscal balance should come from spending cuts or tax increases. But he’s not wrong that S&P’s “research update” is a big deal.

Mohamed El-Erian, the CEO of PIMCO, the world’s biggest bond fund, saw reason to respond. The Treasury Department chimed in too, immediately and defensively: “As the President said last week, addressing the current fiscal situation is well within our capacity as a country. He has initiated a bipartisan process that will allow us to make progress on a balanced approach to restoring fiscal responsibility …. [W]e 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.”​

But this is the same Congress that has spent most of the past few weeks bickering about Planned Parenthood, trying to defund the health care law, and not raising the debt ceiling. Again, S&P is saying that the problem is one of political will, rather than budgetary reality—and it is right about that.

That is why S&P seems to think the year 2013 is so important. The analysts do not think the United States can get its fiscal act together before the 2012 election. That is because changing the country’s fiscal policy is going to require bipartisan cooperation, as well as politically unpalatable program cuts and tax increases, and members of Congress are unlikely to support either option until just after voters can hold them accountable. By then, the United States’ peers, like Britain, will already be a few years into their plans. Thus, S&P’s analysts write, “Even in our optimistic scenario, we believe the U.S.’s fiscal profile would be less robust than those of other ‘AAA’ rated sovereigns by 2013.”

So does this augur higher borrowing costs? Not right now. Stocks sunk on the news, but the bond markets shrugged it off entirely. (Business Insider described the bond rally, not unreasonably, as the “Market’s Middle Finger to S&P.”) That might be because the S&P is not telling anyone who trades bonds anything they do not already know: America has a lot of debt and a gridlocked political system. But it also has resources to pay investors back and a healthier economic outlook than some of its peers. Indeed, all debt ratings are relative. If the United States remains a more attractive place for investors than countries like Canada, France, or Germany, its debt rating should not change. (Of course, Canada and Europe have their own issues.)

Still, the report underscores the fact that we are stuck figuring out a multitrillion math puzzle with the Congress we have. There is no shortage of deficit reduction plans in Washington, from Paul Ryan’s to President Obama’s to Simpson-Bowles to the do-nothing plan. Until Congress gets the will to act, such warning shots will only get louder and louder, until ultimately the bond market won’t just shrug them off.