The First Step Towards National Suicide: America Loses Its AAA Rating

by John Hawkins | July 21, 2011 6:34 am

Treasury Secretary Timothy F. Geithner[1] said the U.S. is in no danger of losing its Aaa debt rating even though the Obama administration has predicted a $1.6 trillion budget deficit in 2010.

“Absolutely not,” Geithner said, when asked in an ABC News interview broadcast yesterday whether a downgrade is a concern. “That will never happen to this country.” — 02/08/2010

Egan-Jones is the first, but sadly, it probably won’t be the last[2].

Credit rating agency Egan-Jones has cut the United States’ top credit ranking, citing concerns over the country’s high debt load and the difficulty the government faces in significantly reducing spending.

The agency said the action, which cut U.S. sovereign debt to the second-highest rating, was not based on fears over the country not raising its debt ceiling.

Instead, the cut is due the U.S. debt load standing at more than 100 percent of its gross domestic product. This compares with Canada, for example, which has a debt-to-GDP ratio of 35 percent, Egan-Jones said in a report sent on Saturday.

A lot of people will wave this off because it’s not Moody’s or Standard & Poor’s, but they shouldn’t. This fight over the debt ceiling is a symptom, not the real disease. The real problem we have in this country is that our level of spending appears to be increasingly unsustainable, even over the medium-term, yet there seems to be very little appetite for dealing with the problem seriously. In fact, if you watch what the Democratic Party does, as opposed to politically motivated lip service Democrats give on the issue, you’d think we didn’t have a problem at all.

Unfortunately, that’s not the case and most Americans are unaware of how close we are to an absolutely devastating economic setback that we could conceivably never recover from in the lifetimes of anyone reading this post. All it would take is Moody’s and Standard & Poor’s joining Egan-Jones and an economic apocalypse would begin to swing into place[3].

The direct consequences of a downgrade of Uncle Sam’s credit on U.S. public finances would be pretty bad. But, as with natural disasters, the aftershocks of this man-made catastrophe might prove more devastating than the main event. In this case, imagine a tsunami of rolling corporate downgrades following the earthquake of a Treasury downgrade, a run on the banks, a discredited FDIC, frozen money-market funds, and a plunging dollar.

…Here’s what Fitch says: “Ratings on bonds with direct credit enhancement provided by Fannie Mae, Freddie Mac, or other GSEs would generally reflect the ratings of the credit enhancement provider.” In English: If the government isn’t AAA, nothing that the government backs is AAA, either.

Fitch also warns that money-market funds could face “liquidity pressure,” something to keep in mind if there’s a run on downgraded banks backed by a downgraded FDIC.

So, who’s who in this world of hurt?

The ten major holders of U.S. Treasury debt are, in order: 1. the Fed, which has more than doubled its holdings of U.S. sovereign debt in the past few years; 2. individual investors, mostly in the United States; 3. the Chinese; 4. the Japanese; 5. pension funds; 6. mutual funds; 7. state and local governments; 8. the Brits; 9. the banks; and 10. insurance companies. (More here.) The national governments have worries of their own already – some of them are in pretty dire straits (the Japanese national debt is 200 percent of GDP) and some of their situations are basically unknowable (China). God alone knows what the Fed will do.

…State and local governments are holding another $1 trillion or so in Treasuries, meaning that the credit profile of our already struggling states and cities would have about as much credibility as Dominique Strauss-Kahn’s wedding vows.

…Back to those banks and insurance guys: Contrary to what our dear leaders in Washington have claimed, the world’s financial system has not been reformed. In fact, a great deal of the bailouts and the legislation that followed them was designed specifically to prevent the kind of fundamental reforms that are needed. A global financial system brought to its knees by a raft of bad mortgages is going to be knocked ass-over-teakettle by a downgrade of U.S. Treasury debt.

…The thing that has not been sufficiently understood, I think, is this: The United States is not on a downgrade watch because the markets fear we won’t raise the debt ceiling in time to avoid a default; the United States is on a downgrade watch because the markets believe the debt-ceiling debate presents the last real opportunity for the government to enact a meaningful fiscal-reform program before it is well and truly too late to avoid a national crisis. The credit agencies, wisely or not, aren’t worried about the short-term political fight leading to an immediate default, but about the near- to medium-term fiscal situation, which is plainly unsustainable.

Losing our AAA credit rating would be like falling off the side of a cliff and rolling all the way down to the ground and, folks, Uncle Sam’s first toe is already hovering in the air and he’s struggling to get his balance.

  1. Timothy F. Geithner:
  2. probably won’t be the last:
  3. economic apocalypse would begin to swing into place:

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