Debt Ceiling Breach, Government Shutdown Threats Reignite Debate About US Credit Downgrade

It’s déjà vu all over again from Washington to Wall Street as politicians revisit the battle over government funding and the debt ceiling a scant two years after the last showdown that led to the historic downgrade of the U.S. credit rating.

Once again, the full faith and credit of the United States moves front and center.

The sacrosanct notion that the U.S. will always and forever pay its borrowing obligations is again the talk of Wall Street and Washington as two major budget issues, the federal spending authority and the government debt limit, must be addressed soon.

Highlighting the issue, Treasury Secretary Jack Lew warned congressional leaders Wednesday that the debt ceiling will be reached “no later than Oct. 17,” at which point he will have exhausted emergency borrowing measures and would have only approximately $30 billion on hand to pay the nation’s bills.

“This amount would be far short of net expenditures on certain days, which can be as high as $60 billion,” Lew wrote in a letter to Speaker of the House John Boehner. “If we have insufficient cash on hand, it would be impossible for the United States of America to meet all of its obligations for the first time in our history.”

Not everyone takes the same position, though, and Daniel J. Mitchell, a senior tax analyst at the libertarian Cato Institute said, “We’re collecting about $3 trillion in revenue, and interest on the debt is about $230 billion. There’s no way that we’ll ever default. The people who are making that argument either are genuinely stupid or they’re being deliberately dishonest.”

Mitchell also dismissed any impact from rating agency actions, mincing no words. “When the ratings agencies downgraded the U.S. -- when was it, last year or the year before -- interest rates went down on government debt. In other words, these people don’t know what they’re talking about. “The credit rating agencies are very incompetent people.”

He added his contention, shared by many, that the markets are much better at pricing in the possibility of default than the credit rating agencies.

So, if the government does come to a grinding halt next month, would the credit rating agencies again downgrade the U.S., and if so, what would be the likely consequences?

Moody’s answer regarding a downgrade is, “no, but ... ”

In a report issued Tuesday, the rating agency said that as far as it’s concerned, neither a shutdown nor breaching the debt ceiling would trigger a downgrade -- but either would disrupt markets and cause economic pain. However, “We view the upcoming deadlines as possibly short-term disruptions. Even if there were to be a brief government shutdown or some delay in raising the debt limit, these short-term events would not materially affect the factors upon which the rating is based. Our rating of the U.S. is based on medium- to long-term trends in government deficits and debt.”

On Aug. 5, 2011, the last time Washington’s brinksmanship threatened the nation’s credit rating, the politicians blinked and the rating agencies downgraded the U.S. debt, opining that, “We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues, is less likely than we previously assumed and will remain a contentious and fitful process.”

This time around, that same threat hangs in the air, but the issues are more about political will than political posturing.

The U.S. has been scraping up against the $16.7 trillion debt ceiling since May, but it has been able to avoid defaulting on any of its obligations by employing emergency measures to manage its cash, such as suspending investments in pension funds for federal workers.

From one Congressional perspective, a downgrade from the rating agencies would be damaging to the nation.

Rep. Tim Huelskamp, R-Kan., told IBTimes that, “I would suggest a downgrade is likely if we do not show some progress on getting our fiscal house in order. The way you avoid a downgrade is you actually go to work, figure out a plan. I’ve been one of the few that raised the specter of a downgrade. A default is not going to happen. … There is plenty of sums coming in, so default’s not the issue. The issue is the downgrade and there’s some folks in reading the downgrade from S&P and part of that was, well, we couldn’t get our act together, but part of it as well is, there is no plan, there is no short, medium and long-term plan.”

Huelskamp argues that at the issue’s heart it’s not just the political bickering that led to the last downgrade, but the numbers that mattered too.

“At the end of the day when you’re carrying $17 trillion in debt and you want another one or two trillion and you’ve got no plan to figure out how you get at least to balance,” he said. “That does lead to a potential downgrade, and I’m worried about that. And it’s not the failure in my mind, it’s not the failure to give the president a blank check and max out the credit card, raise the credit card, I don’t think that’s going to create the downgrade -- or it’s not going to avoid the downgrade.”

In addition to all the mudslinging and political posturing one issue remains unavoidable and poses more of a threat to the county than others. That’s the U.S. credit rating.

In June, with the Washington chattering class still several months away from the current showdown, Moody’s Investor Services said in a published research note that, “[D]espite the more favorable fiscal outlook over the next several years, without further fiscal consolidation efforts, government deficits are anticipated to increase once again over the longer term. If left unaddressed, over time this situation could put the rating again under pressure.”

In other words, “Congress, you need to get serious …. ”

Fitch, another of the big rating agencies also weighed in on the subject in June, saying that failure to raise the federal debt ceiling at least several days prior to when the Treasury will have exhausted extraordinary measures and cash reserves “will prompt a formal review of the U.S. sovereign ratings and likely lead to a downgrade.”

Pema Levy contributed reporting for this story.