The Impact of a Potential Downgrade on the United States Credit Rating

[mheslep]

Any deal struck in the next few days will include no ACTUAL spending cuts, only PROMISED spending cuts. Given that Reagan agreed to a similar deal in the 80s and the spending cuts never happened, I wonder if the rating agencies care at all about the "deal" we get? Ultimately, spending cuts can only happen through a budget.

Eh, from my understanding, such as it is, the House plan has a large and real difference this time. In the Reagan case Democrats in congress promised Reagan 3:1 cuts after the fact for taxes raised in the http://en.wikipedia.org/wiki/Tax_Equity_and_Fiscal_Responsibility_Act_of_1982" which Reagan signed, and after which the Congress reneged with a follow on appropriations bill which became law by overriding Reagan's veto. The point being from back then that the promised cuts were never law.

http://cbo.gov/ftpdocs/123xx/doc12341/HouseBudgetControlActLetterJuly27.pdf", if the Senate passes the House plan and Obama signs it, then the cuts spelled out there become law, and they will occur unless a majority of the House and Senate in coordination with the President all take positive action in the future to stop them from taking place. That is, if the future Congress never showed up then without this proposed law most authorized spending will increase on autopilot. Similarly, with this law in place, if a future Congress never showed up then the same authorized spending will fall by ~$1 trillion/10 years, and $22 billion in 2012.

This is nowhere near enough in cuts, but then it can be revisited in six months when the credit line again runs out.

 

[russ_watters]

There are no cuts outlined there, only a global spending cap, completely lacking in specifics. And the joint action that could override this bill is called the 2012 budget!

 

[mheslep]

And the joint action that could override this bill is called the 2012the budget!

And if the caps were blown out in that budget, the Republican House would have actively go along with it. No way.

 

[Char. Limit]

So what do you think the odds are that we'll ACTUALLY default?

I want a number.

 

[WhoWee]

This is nowhere near enough in cuts, but then it can be revisited in six months when the credit line again runs out.

This is the reality at the end of the day - isn't it? IMO - the results of the 2010 didn't convince our leaders - we will not have clarity on this subject until after the 2012 election.

 

[WhoWee]

So what do you think the odds are that we'll ACTUALLY default?

I want a number.

IMO - we have a 0% chance of default. Maybe the question should be "what is the chance of the Dems forcing a Presidential end run with the 14th Amendment"? I expect a last minute swoop-in by the President on August 3 to "save the day".

 

[mheslep]

There are no cuts outlined there, only a global spending cap, completely lacking in specifics. ...

In addition to the caps ...

...Eliminate the subsidized loan program for graduate students. Beginning July 1,
2012, the bill would eliminate the interest subsidy...

...Eliminate loan repayment incentives. Beginning July 1, 2012, the bill would
terminate, with one exception, the Secretary of Education’s authority to make
incentive payments to borrowers

 

[mheslep]

http://www.nationalreview.com/corner/272996/bind-ramesh-ponnuru" says more succintly what I was about to say:

One thing we’re hearing a lot from Boehner-plan skeptics today is the refrain that “one Congress can’t bind another”: It’s better to get spending cuts front-loaded, because future Congresses can always exceed any caps. That’s true. But of course by the same token future Congress can always reverse today’s spending cuts in full. The question is what actions can be taken now to influence future spending. Front-loaded cuts would help. But so would legally enforceable spending caps of the sort found in the Boehner plan. Yes, future Congresses can waive them. But so long as supporters of the caps hold the House, the Senate, or the presidency they can maintain them. Without caps written in law, it would be easier for the appropriations bills to exceed them without there ever being a single vote on the total.

 

[SixNein]

Any deal struck in the next few days will include no ACTUAL spending cuts, only PROMISED spending cuts. Given that Reagan agreed to a similar deal in the 80s and the spending cuts never happened, I wonder if the rating agencies care at all about the "deal" we get? Ultimately, spending cuts can only happen through a budget.

The republican bill has specific cuts for students.

Of course, it also brings the topic back up in 6 months.

 

[SixNein]

http://www.nationalreview.com/corner/272996/bind-ramesh-ponnuru" says more succintly what I was about to say:

Front end cuts are not a good idea because we have a very fragile economy.

 

[SixNein]

So what do you think the odds are that we'll ACTUALLY default?

I want a number.

My reaction is to say zero percent chance; however, many members of congress have yet to drop political posturing, and there is only 5 days left. They are certainly showing willingness to do economic harm by playing this debt limit thing for so long. This debate is now an international issue.

 

[mheslep]

Front end cuts are not a good idea because we have a very fragile economy.

I don't buy the spending stimulates the economy argument any more, at all. Rather I think that, absent serious front end cuts, people will reasonably calculate:
1 future tax increases to pay for the mounting debt
2 the collapse of medicare and SS
3 a credit rating downgrade accelerating 1 & 2.
4 more money printing to inflate away both the debt and their savings.
5 http://en.wikipedia.org/wiki/Permanent_income_hypothesis"

 

[WhoWee]

I don't buy the spending stimulates the economy argument, at all. Rather I think that, absent serious front end cuts, people will reasonably calculate:
1 future tax increases to pay for the mounting debt
2 the collapse of medicare and SS
3 a credit rating downgrade accelerating 1 & 2.
4 more money printing to inflate away both the debt and their savings.
5 http://en.wikipedia.org/wiki/Permanent_income_hypothesis"

...yep

 

[mheslep]

So what do you think the odds are that we'll ACTUALLY default?

I want a number.

Default on interest on the debt near zero, yes, but the debt limit and credit rating downgrades are a different story. According to the "wisdom of the crowd", the chance as of tonight that the debt limit will be raised by July 31 is 12%.
[PLAIN]http://www.intrade.com/jsp/intrade/common/images/homepage/cachedGraphs/745701.png

The chance as of tonight of raising it by the end of August is similarly 83%
[PLAIN]http://www.intrade.com/jsp/intrade/common/images/homepage/cachedGraphs/749123.png

Chance of a US credit downgrade by 2013 is ~60%
[PLAIN]http://www.intrade.com/jsp/intrade/common/images/homepage/cachedGraphs/748842.png

Summarizing the crowd: the debt limit will not be raised by August 2 and some checks will be skipped before a deal is eventually struck by the end of August. However the deal will not adequately address the deficit leading a credit downgrade.

 

[WhoWee]

Does anyone remember this interview - 3 months ago?
http://www.guardian.co.uk/business/2011/apr/19/geithner-shrugs-off-credit-rating-warning

"Tim Geithner, the US treasury secretary, shrugged off warnings from a leading ratings agency about the US public finances as he sought to reassure Wall Street that the world's biggest economy would be able to maintain its highly prized AAA rating.

In a media blitz following the announcement by Standard & Poor's that it had revised its outlook on the US from stable to negative, Geithner said there was "no risk" of a downgrade."

Let me repeat - this was 3 months ago.

 

[That Neuron]

Many economists are predicting that America will get downgraded from AAA by at least one agency regardless if congress raises the debt limit.

Does that mean we won't get roadside service any more...? Lol

 

[drankin]

Does anyone remember this interview - 3 months ago?
http://www.guardian.co.uk/business/2011/apr/19/geithner-shrugs-off-credit-rating-warning

"Tim Geithner, the US treasury secretary, shrugged off warnings from a leading ratings agency about the US public finances as he sought to reassure Wall Street that the world's biggest economy would be able to maintain its highly prized AAA rating.

In a media blitz following the announcement by Standard & Poor's that it had revised its outlook on the US from stable to negative, Geithner said there was "no risk" of a downgrade."

Let me repeat - this was 3 months ago.

Is anyone else getting the idea that these guys don't know wtf they are doing?

 

[WhoWee]

Is anyone else getting the idea that these guys don't know wtf they are doing?

This was 2 years ago: my bold
http://www.freerepublic.com/focus/news/2262284/posts

"China is the biggest foreign owner of U.S. Treasury bonds. U.S. data shows that it held $768 billion in Treasuries as of March, but some analysts believe China's total U.S. dollar-denominated investments could be twice as high.

"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

His answer drew loud laughter from his student audience, reflecting scepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.

The Beijing-based Global Times greeted Geithner by publishing a survey of Chinese economists who called big holdings of U.S. debt "risky."

Geithner renewed pledges that the Obama administration would cut its huge fiscal deficits and promised "very disciplined" future spending, possibly including reintroduction of pay-as-you-go budget rules instead of nonstop borrowing. "

 

[WhoWee]

I'll give turbo credit for this - if he so desires? Turbo pointed out in another thread that SS holds nearly $3 of the $14.3Trillion US debt.

http://www.politifact.com/virginia/...llen-says-china-owns-more-us-bonds-americans/


"The national debt stands at $14.3 trillion. Nearly $6 trillion of that is held by the Federal Reserve and U.S. government agencies in various funds such as the Social Security Trust Fund.

The rest of the amount, about $8.3 trillion, is "privately-held" debt owed to mutual funds, pension funds, foreign investors and other bond holders.

There’s no doubt China holds a lot of U.S. government debt. In fact, it’s the largest foreign owner of U.S. Treasury securities.

As of March 2011, China owned about $1.2 trillion of U.S. debt - more than a quarter of the total $4.5 trillion in U.S. treasuries held by foreign investors, according to statistics from the U.S. Treasury Department. But the rest of the roughly $3.8 trillion of privately held debt was owned by United States investors such as banks, pension funds and mutual funds."

Perhaps the adults in the room need to sit down and put a plan together to stop the pocket-to-pocket transfer game - write down the bad investments - and balance the real books? I realize this will require the persons sitting at the table bring more than rhetoric but the outcome could restore our standing in the world.

If all we actually owe China (in Treasuries) is $1.2Trillion - we should pay them off. As for Social Security - let's write off the amounts spent - pay the interest owed - and both increase the cap and the age of eligibility. The $3.8Trillion held by US investors should be re-negotiated and extended with BONUS interest! It's time to think like the Captains of Capitalism.

 

[AlephZero]

If all we actually owe China (in Treasuries) is $1.2Trillion - we should pay them off.

You don't have any money to pay them off with. Apple Computer now has bigger cash reserves ($76bn) than the US government ($73bn):
http://www.bbc.co.uk/news/technology-14340470

 

[WhoWee]

You don't have any money to pay them off with. Apple Computer now has bigger cash reserves ($76bn) than the US government ($73bn):
http://www.bbc.co.uk/news/technology-14340470

Obviously - I meant to prioritize their amount and pay it over a few years.

As for the $3Trillion held by Social Security - it doesn't make sense to include this amount in the national debt - when the future unfunded amount is significantly larger. If we write off the Social Security amount - the debt would be reduced by that amount and put us well under the legal cap.

 

[AlephZero]

Obviously - I meant to prioritize their amount and pay it over a few years.

China is in control of that option, not the US. All it has to do is cut back on buying more T-bonds as the existing ones come due for repayment. The only option the US has to continue its current debt levels (let alone increase them) is to keep issung new bonds to fund the repayments of the old ones as they mature. If China isn't prepared to "recycle" its debt and buy new bonds for old, you have to find somebody else to take up the slack. That means either US interest rate rises, or dollar devaluation (and the dollar has already devalued more than 50% against the Swiss Franc over the past 12 months - I wonder what that tells you about where smart and rich US ciitizens have put their money already.)

Given the noises from China about "the effects on the rest of the world when the elephant and the donkey fight", it's quite likely they will cut back anyway, regardless of what political nonsense the US comes up with to paper over the cracks. Sure, that will hurt Chinese exports to the US, but big deal. China isn't a democracy. It doesn't have a political system where the first (or only) priority of everybody in the system is to get re-elected.

If you want to have a trade war, starting with foreign reserves of +$X Tn is a better place to be than starting with -$X Tn...

 

[WhoWee]

China is in control of that option, not the US. All it has to do is cut back on buying more T-bonds as the existing ones come due for repayment. The only option the US has to continue its current debt levels (let alone increase them) is to keep issung new bonds to fund the repayments of the old ones as they mature. If China isn't prepared to "recycle" its debt and buy new bonds for old, you have to find somebody else to take up the slack. That means either US interest rate rises, or dollar devaluation (and the dollar has already devalued more than 50% against the Swiss Franc over the past 12 months - I wonder what that tells you about where smart and rich US ciitizens have put their money already.)

Given the noises from China about "the effects on the rest of the world when the elephant and the donkey fight", it's quite likely they will cut back anyway, regardless of what political nonsense the US comes up with to paper over the cracks. Sure, that will hurt Chinese exports to the US, but big deal. China isn't a democracy. It doesn't have a political system where the first (or only) priority of everybody in the system is to get re-elected.

If you want to have a trade war, starting with foreign reserves of +$X Tn is a better place to be than starting with -$X Tn...

First, who decided to depend on China to finance our Government and secure our retirement and safety net programs?

A little history lesson - after WWII the US refinanced the German and Japanese economies with debt - correct? Had those investments been converted to equity - even 25% - we would be in a much stronger position now. Instead, US companies (autos and electronics for instance) were forced to compete with re-invigorated Japanese and German firms.

Now, politicians pave the way to send our manufacturing base to China (and elsewhere) to lower labor costs (pushed up by unions). The Chinese factories were happy to sell products at break-even to gain market share. As the cash flows out of the US into China - factories close in the US and certain retailers flourish selling cheap Chinese goods. This time we have financed China with manufacturing contracts. As China acquires dollars - we are more than happy to borrow from them to fund our spending. The Chinese are also happy to purchase as many natural resources around the world as possible.

What happens when the Chinese decide not to loan us any more money - or demand a higher interest rate? We already borrow about 40% of our budget - who will loan us money to pay China in the future?

The USA needs a long term plan. IMO - the whole "super power" label has gone to our heads in that unless we plan to not pay our debts - we are in big trouble.

Are the best days of the US in the past or in the future - and what is the definition of "best days"? If best days are defined by full employment and prosperity - the plan must be real - not pie-in-the-sky industries that don't yet exist. If the best days is defined as a welfare state where the wealthiest 1% and the top corporations pay to feed, clothe, house, and provide medical care to everyone else - that plan also needs to be precise.

Hopefully these choices will become clear to voters in the 2012 election - the financial markets are not fooled by political rhetoric as they look closely at the actual numbers.

 

[WhoWee]

THIS IS A MUST HEAR INTERVIEW!

According to Barney Frank - the recent financial reform legislation - in anticipation of a downgrade - removes the federal requirement that AAA securities be liquidated (by pensions for instance) in the event of a downgrade. He stipulated the statuatory requirements have been removed and the regulatory rules are being disassembled currently.

http://video.foxnews.com/v/1087633549001/credit-rating-downgrade-a-done-deal/

 

[Ryan_m_b]

The USA needs a long term plan. IMO - the whole "super power" label has gone to our heads in that unless we plan to not pay our debts - we are in big trouble.

Are the best days of the US in the past or in the future - and what is the definition of "best days"? If best days are defined by full employment and prosperity - the plan must be real - not pie-in-the-sky industries that don't yet exist. If the best days is defined as a welfare state where the wealthiest 1% and the top corporations pay to feed, clothe, house, and provide medical care to everyone else - that plan also needs to be precise.

Hopefully these choices will become clear to voters in the 2012 election - the financial markets are not fooled by political rhetoric as they look closely at the actual numbers.

IMO the biggest problem with this whole default crisis is that the average person doesn't entirely understand the situation (i.e. how can a country owe money and to who?) and has a bit of a cognitive dissonance believing that the US will always be number-one.

 

[MarcoD]

What happens when the Chinese decide not to loan us any more money - or demand a higher interest rate? We already borrow about 40% of our budget - who will loan us money to pay China in the future?

Man, don't worry about it. At the moment, China trades goods for paper, and part of that paper is used to buy other stuff like oil. I think it is pretty unlikely that China will get an equivalent amount of goods back, the paper will just devalue.

 

[Ryan_m_b]

Man, don't worry about it. At the moment, China trades goods for paper, and part of that paper is used to buy other stuff like oil. I think it is pretty unlikely that China will get an equivalent amount of goods back, the paper will just devalue.

Errr what? China has US bonds and you have a large debt with them. Modern economies rely on being in a constant state of debt and lending, if suddenly people won't lend to you or ask for a higher interest rate you're going to suffer.

 

[MarcoD]

Errr what? China has US bonds and you have a large debt with them. Modern economies rely on being in a constant state of debt and lending, if suddenly people won't lend to you or ask for a higher interest rate you're going to suffer.

I misunderstood it I think, must have been thinking about something else.

As far as I know bonds are traded in some manner on the free market. If China suddenly stops buying, I guess interest rates would suddenly [STRIKE]drop[/STRIKE] increase. Otherwise, interest rates I guess will remain the same - they don't determine interest rates, the market does.

Is it possible that if China doesn't buy back bonds not enough bonds can be sold and US government defaults because they don't receive money from the market? I actually have no idea. Negative interest rates? Deflation? Is it even possible for China not to buy back bonds? Where would all the money go, in ships from the US to China? I really have no idea.

But as far as I know, all that money abroad has nowhere to go, and China has no interest in suddenly destabilizing the market.

 

[Ryan_m_b]

I'm not an expert either but start here and work your way through if you want to know more. Whilst I'm sure China doesn't want to destabilize the market it's not really under their control. The US owes many countries money (Including the UK). Defaulting means that the US will miss a payment, this will have huge obvious knock on effects such as the companies/countries relying on that money coming in not being able to pay for stuff either. The result will be that the US has it's credit rating reduced meaning people will be less likely to lend it money and would do so at higher interest rates.

 

[MarcoD]

I'm not an expert either but start here and work your way through if you want to know more. Whilst I'm sure China doesn't want to destabilize the market it's not really under their control. The US owes many countries money (Including the UK). Defaulting means that the US will miss a payment, this will have huge obvious knock on effects such as the companies/countries relying on that money coming in not being able to pay for stuff either. The result will be that the US has it's credit rating reduced meaning people will be less likely to lend it money and would do so at higher interest rates.

I never thought, and still don't think, that they will default, so this is just academic interest.

If we don't generalize anymore on national terms (getting tired of the US/China divide, China banks just hold 1Tn I thought), but think in terms of banks, financial institutions, private investors and companies: would the interest even go up that much?

Most institutions/small time investors can find other places to go with their money, but does the same hold true for banks or big funds?

I mean, are all the international banks not just that much tied up in US debt that they have no other option than to (re-)buy US debt with their dollars, no matter what? Or even, does an informal agreement exist between all these banks that it is just better to roll over debt of the US because of the consequences if they don't? They have a lot to lose if the US economy stalls, and suppose one of them owns several hundreds of millions of US debt, what could it do with it? Buy gold? They would suddenly need to find another market which would be big enough and deliver the same yield, and they would need to do that fast - money just standing around loses value.

Maybe losing AAA doesn't mean anything.

If the amount of money 'fighting' to be reinvested hardly changes, the interest rates can't change. If the amount of money, next time US debt is rolled over, suddenly dramatically changes -even if they strike a deal, but banks find it now necessary to reposition- I guess interesting times are ahead anyway.

 

[Ryan_m_b]

I never thought, and still don't think, that they will default, so this is just academic interest.

We'll see, there is a real and frightening chance that they will.

If we don't generalize anymore on national terms (getting tired of the US/China divide, China banks just hold 1Tn I thought), but think in terms of banks, financial institutions, private investors and companies: would the interest even go up that much?

Most institutions/small time investors can find other places to go with their money, but does the same hold true for banks or big funds?

I mean, are all the international banks not just that much tied up in US debt that they have no other option than to (re-)buy US debt with their dollars, no matter what? Or even, does an informal agreement exist between all these banks that it is just better to roll over debt of the US because of the consequences if they don't? They have a lot to lose if the US economy stalls, and suppose one of them owns several hundreds of millions of US debt, what could it do with it? Buy gold? They would suddenly need to find another market which would be big enough and deliver the same yield, and they would need to do that fast - money just standing around loses value.

Maybe losing AAA doesn't mean anything.

If the amount of money 'fighting' to be reinvested hardly changes, the interest rates can't change. If the amount of money, next time US debt is rolled over, suddenly dramatically changes -even if they strike a deal, but banks find it now necessary to reposition- I guess interesting times are ahead anyway.

Essentially it will make borrowing a lot harder for the US and increase it's debt. Whilst it is true that it is in no-ones interest to see the US economy stall (well actually I would dispute that, many countries could see a boost by filling the gaps that the US leaves) that doesn't give the US a get-out-of-jail-free card.

The institutions and countries that hold US debts might need that money, it's not a case of "don't worry about it I know you're good for it". For example;
Alice lends Bob 10 credits in return for an IOU. Alice then wants to buy 10 credits of goods from Carol and so gives Carol Bob's IOU. If Bob suddenly can't pay both Alice and Carol are in trouble and in future Alice will be less inclined to lend to Bob and Carol will value a Bob IOU less. So yes the US is a huge part of the global economy and there would be dramatic consequences if it defaults, the result will be repercussions in the market as people's money vanishes (a good example would be the US troops in Afghanistan who may not get paid next month) and in the future the US takes an ever decreasing roll on the global stage. If the US defaults and gets it's credit rating down rated businesses will move to other countries where their money is safer.

 

[SixNein]

IMO the biggest problem with this whole default crisis is that the average person doesn't entirely understand the situation (i.e. how can a country owe money and to who?) and has a bit of a cognitive dissonance believing that the US will always be number-one.

In addition to the above, many people seem to believe that America's budget and economic problems have 'obvious' solutions. But I don't see anything obvious about these problems. Some people think we should 'obviously' make deep spending cuts, and others think we should 'obviously' stimulate the economy. There is nothing obvious about either decision, and there is nothing obvious about how much one should pursue the path of either choice. Either path in my mind comes with substantial risk and uncertainty.

Just take the topic of a tax cut stimulus. Many will argue that tax cuts are the best way to stimulate the economy, but how can they be so sure? A great deal of our consumer goods are from foreign lands, so tax cuts may stimulate foreign economies instead of the American economy. We went with substantial tax cuts to stimulate the economy without ever asking important questions; as a result, we may be subsidizing economic growth in China instead of America.

In my mind, the largest problem America has right now is its lack of production. America is by and large a financial economy that just suffered a major financial collapse, and we don't have a backup plan. So how do we recover from this situation?

 

[WhoWee]

THIS IS A MUST HEAR INTERVIEW!

According to Barney Frank - the recent financial reform legislation - in anticipation of a downgrade - removes the federal requirement that AAA securities be liquidated (by pensions for instance) in the event of a downgrade. He stipulated the statuatory requirements have been removed and the regulatory rules are being disassembled currently.

http://video.foxnews.com/v/1087633549001/credit-rating-downgrade-a-done-deal/

Did anyone listen to this interview with Barney Frank? Apparently (and contrary to rhetoric -a reference to Geithner comments just 3 months ago), the Dems have anticipated a downgrade (for about a year?) and took steps in the finance Bill to offset some of the damage.

 

[Ivan Seeking]

Did anyone listen to this interview with Barney Frank? Apparently (and contrary to rhetoric -a reference to Geithner comments just 3 months ago), the Dems have anticipated a downgrade (for about a year?) and took steps in the finance Bill to offset some of the damage.

He was talking specifically about municipalities [and I think some States]. And what's news isn't the downgrade of some bonds, it is that the Fed is not requiring an automatic sell [by the banks] due to a downgrade. Arguably some of these bonds should have been downgraded long ago, so in practical terms, a downgrade does not mean there is an increased risk.

 

[WhoWee]

He was talking specifically about municipalities [and I think some States].

listen to the entire interview - he also references pensions/funds.