By Peter Schroeder - 05/25/12 06:17 PM EDT
Rating agencies are warning that the federal government risks another downgrade of its creditworthiness if it fails to come up with a credible plan this year to lower the federal deficit.
The warning comes amid growing expectations that Washington will punt major tax and spending decisions into next year because lawmakers would have little time to address them in a lame-duck session after the November election.
“It’s highly uncertain ... because of the political circumstances,” said Steven Hess, Moody’s lead analyst for U.S. ratings. “Our stance at this point is to wait and see.”
Action on the debt almost certainly won’t happen before the election, because both parties are building their fall campaigns on differences over taxes and spending.
As a result, the administration and lawmakers are headed for the mother of all lame-duck sessions in November, when Congress must decide whether to raise the debt ceiling, extend the Bush tax rates and replace $1.2 trillion in automatic spending cuts set to begin in January 2013.
Lobbyists on K Street are already expecting the government to agree to a short-term deal in the lame duck that would punt longer-term decisions on taxes and spending into 2013, but possibly extend current tax rates in the short term while slightly raising the debt ceiling.
This would give more time for lawmakers to reform the tax code, a central ingredient in any big deficit deal. It would also buy time for shell-shocked politicians to reassess the political landscape if the White House or a chamber of Congress changes hands.
The agencies are playing their cards close to their chest when it comes to how they’d receive a punt, emphasizing the credibility of a plan above all else.
“We’d have to assess the actual content of any temporary agreement,” Hess said. “How likely is it that that will require a credible plan to be implemented within whatever time frame they come up with? It’s the actual deficit and debt trajectories that we expect that will be the most important determinant.”
Only Standard and Poor’s has so far downgraded the U.S. credit rating, though Fitch and Moody’s have both put the United States on negative outlook, suggesting future downgrades are coming without a change in course.
When Fitch assigned the negative outlook, it identified 2013 as a crucial year for the United States to take action on its debt. Currently, it sees better-than-even odds that it will downgrade the United States, but such a decision would not come until the end of 2013 as it waits to see how the deficit will be addressed following the elections.
Still, experts closely following the debate say a pure punt would raise doubts that the federal government's seriousness on the deficit, raising the chance of an impending downgrade.
“If Congress doesn’t put in place a process that assures people that this will be addressed in a real manner ... then there is no doubt in my mind that our sovereign debt will be downgraded,” said Steve Bell, a former Republican budget staffer who is now the senior director of economic policy at the Bipartisan Policy Center. “Markets throughout the world are going to be looking at the action of the United States government."
While the credit rating agencies’ policies forbids publicly discussing talks with political leaders on their ratings, sources said regular technical policy discussions take place between the agencies and Washington policymakers, as they do with all other governments that receive credit ratings.
The rating agencies are under enormous pressure on the U.S. credit rating. Their reputations took a big hit during the financial crisis, when they gave good bills of health to financial products that ended up being worthless.
They’re watching the discussions in Washington closely, and so far, they are concerned by what they’re hearing.
“The rhetoric that’s being formed is causing a lot of uncertainty,” said Beth Ann Bovino, deputy chief economist for Standard & Poor’s.
Bovino, an economist for S&P who does not set ratings for the U.S., said Speaker John Boehner’s (R-Ohio) recently reiterated pledge that Republicans will not raise the debt ceiling again without deep spending cuts was a “déjà vu” moment — a stark reminder of the ugly financial fight that precipitated the first downgrade. Boehner’s camp maintains the Speaker is being responsible by pressing fiscal matters before the election in an effort to get the nation’s debt under control.
Bovino cautioned that if Congress fails to act, the ensuing policy will amount to “austerity by default” and would “put a wrench into the wheel of this recovery.”
However, she does expect lawmakers to strike some sort of compromise in time.
While her job is not to set the nation’s rating, she hit the same note as Hess in emphasizing credibility, saying it was incumbent upon Congress to come up with a “credible medium-term plan, which is what investors and the economy would need.”