News Column

Concerns Persist That Credit Rating of U.S. Will Slide

Aug. 4, 2011

Mark Davis

Broken piggy bank and american flag

America broke through its debt-ceiling woes Tuesday and partially preserved its AAA credit rating, at least for now.

Washington struck a deal that avoided a massive government cash shortage that could have meant an unprecedented default or at least a sudden and economically damaging cutback in federal spending.

It was enough for Moody's Investors Service Inc. to "confirm" its AAA rating of the Treasury's debt Tuesday. But the rating agency said its outlook turned "negative," which meant it might yet change its mind on the rating.

The other two prominent rating agencies were less ready to act.

Fitch Ratings called the debt-ceiling measures "a step in the right direction" but added that the nation's finances were still on a trend "that is not consistent with the United States retaining its 'AAA' rating." Fitch said it will continue its review through the end of August before deciding whether the rating stays.

Standard & Poor's Corp. didn't weigh in on Tuesday. However, in mid-July S&P warned that there was a 50-50 chance it would downgrade U.S. debt.

"We avoided one clear line in the sand. We avoided this big default and government shutdown," said Eric Kelley, managing director of fixed-income investments at UMB Wealth Management in Kansas City. "We're going to have to wait and see how much more we've avoided, with what Washington has done."

The nation's AAA rating has allowed the U.S. government to borrow cheaply and virtually without limit for decades. It became especially important once the financial crisis and recession reduced tax receipts well below federal spending levels and boosted the need to borrow.

Washington's repeated failure to raise the debt ceiling and address credit-rating issues had weighed on investors until the deal finally unfolded over the weekend. Those worries, however, increasingly have been replaced by concerns about the weakening economic recovery.

Consumers cut their spending in June, the first monthly drop since September 2009, according to the Commerce Department on Tuesday. The unexpectedly weak report followed Monday's news of a surprise slowdown in manufacturing activity in July and last Friday's surprisingly weak measures of the nation's Gross Domestic Product through the first half of the year.

The Dow Jones industrial average fell 265.87 points, or 2.2 percent, on Tuesday to close at 11,866.62. The drop in the Standard & Poor's 500 index pushed it into negative territory for the year.

Some money managers complained that the debt-ceiling deal that Congress passed and President Barack Obama signed left too much of the deficit fix unresolved.

"No one is touching entitlements, no one is touching tax reform, and we have yet another commission," Neel Kashkari of Pacific Investment Management Co. told Bloomberg Television. "Do we really need another commission to realize that we just need political courage to make hard choices?"

The deal outlines $917 billion in spending cuts and a plan to trim the deficit by an additional $1.5 trillion.

Moody's said a downgrading could come if Washington's "fiscal discipline" weakened in the coming year, if further measures were not adopted in 2013, if the economic outlook "deteriorated significantly," or if the government's funding costs rose appreciably, which is a reference to higher interest rates.

The debt deal's total spending cuts were short of the $4 trillion in cuts over 10 years that S&P previously said would be needed to preserve the nation's long-term AAA rating and its top-notch credit rating of A-1+ on short-term debt.

Experts were at least offering comfort with predictions that being hit with an AA rating, one notch below the top, wouldn't be so bad.

Financial markets already know about the federal government's deficit problem, argued Peter Fisher, head of fixed-income investing at BlackRock Inc., a large New York money management firm. A credit downgrade would simply show the rating agencies acknowledged those problems.

UMB's experts are saying an AA rating on U.S. Treasury securities probably would increase interest rates on the government's debt, but perhaps only 0.12 of a percentage point higher. Others' borrowing costs could rise too, from homebuyers to corporate treasurers, though not enough to disrupt access to credit.

The reason is fairly simple: Investors would still see U.S. government debt as the safest investment anywhere on the globe. There were signs Tuesday of investors' enduring faith in America's credit amid the worsening economic outlook and continuing doubts about the credit rating.

"People are buying Treasury notes like there's no tomorrow. They're buying mountains of Treasury notes," UMB's Kelley said.

Markets in the government securities of other nations with AAA credit ratings, such as Germany, don't offer enough room to shelter the large flows of money that seek shelter in times of uncertainty. So it's back to Uncle Sam.

This is one reason money managers say they expect no problems with client accounts that specify investing in U.S. Treasury securities. The clients are after safety, and Treasuries would still deliver that. For example, American Century mutual funds, whose rules require them to invest heavily in Treasuries, don't refer to the securities' credit rating.

There even could be some good in a downgrade of America's credit rating, said Gary Cloud, a portfolio manager at Financial Counselors Inc. in Kansas City.

"It's the only lever that politicians can ... use to make the case that reforms need to be made about long-term spending," Cloud said.

Others were still counting the risks of an event the world has never seen before.

Japan, Canada and other nations have lost their AAA ratings and survived well enough, with Canada regaining the top rating. But none of them carried the United States' stature as the largest global economy or its status in global trade, which often is priced in dollars even when trade is between other nations.

Steven Ricchiuto, chief economist at Mizuho Securities USA Inc., scoffed at calculations of how much interest rates might rise or the economy may suffer should America lose its AAA rating.

"There's no way to tell," Ricchiuto said. "We have nothing to compare it to."

To reach Mark Davis, call 816-234-4372 or send email to mdavis@kcstar.com.



Source: Copyright (c) 2011, The Kansas City Star, Mo.