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What a Cut in US Credit Rating Might Do to Business

The US government has dug itself into a debt canyon, and it won't or doesn't know how to stop digging.

While Congress and the Executive Branch of Barack Obama continue to bicker over steps to take in the face of mounting national debts, a third party has revised its outlook on the US government's long-term debt rating to Negative from Stable. In a report, Standard & Poor’s said the US has “what we consider to be very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us.”

There's more. If you don't mind plodding through, click here for the full report. Here's how Standard & Poor's describe the situation it sees:

    We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns.

Before I express my personal view on US indebtedness, let me vent first about the shoddy job Standard & Poor's and other sovereign debt rating firms are doing. Total US public debt is in May expected to exceed the borrowing limit of $14.29 trillion sanctioned by Congress. Our government owes more than $14 trillion, and the deficit is as large as the ocean, Standard & Poor's confirmed. The firm noted that US deficit in 2009 “ballooned to more than 11 percent [of GDP] and has yet to recover,” from between 2 percent and 5 percent of GDP in 2003. Yet, Standard & Poor's is still waiting for the red light to start flashing before downgrading the US credit rating.

What exactly needs to happen before rating agencies serve a stronger warning to the United States government about the price of rising indebtedness? Do we have to become Greece, Ireland, Portugal, or Spain before it become obvious something is seriously wrong here? I know many people continue to argue that debts don't matter. If it doesn't, why is Standard & Poor's hollering now, and why are several European nations groveling before creditors?

The US is in a jam, and rating agencies do a major disservice to countries that are heavily weighed down with debts — and that keep piling them on. In its report, Standard & Poor's sweetened its warning with some caveats about how the US is such a different nation compared with others similarly struggling with high long-term debts and budget deficits.

The US has unique strengths, according to Standard & Poor's. It said further:

  • We have affirmed our 'AAA/a-1+' sovereign credit ratings on the United States of America
  • The economy of the US is flexible and highly diversified, the country's effective monetary policies have supported output growth while containing inflationary pressures, and a consistent global preference for the US dollar over all other currencies gives the country unique external liquidity.

This doesn't sound alarming, and we shouldn't be worrying, right? No. “Although we believe these strengths currently outweigh what we consider to be the US's meaningful economic and fiscal risks and large external debtor position, we now believe that they might not fully offset the credit risks over the next two years at the 'AAA' level,” according to Standard & Poor's credit analyst, Nikola G. Swann.

So, which position should we accept? Is the United States in top condition, poor condition, or somewhere in between? As far as Standard & Poor's is concerned, the US government needs to do something about its current outsized deficits and ballooning long-term debts by 2013 or it will face… what exactly? I expect it will face higher borrowing costs in the short-term and dire unknown consequences in the future.

That's what Standard & Poor's should be concerned about, because everyone knows that despite all the huffing and puffing in Congress, nothing will be done in a mere two years to noticeably slash deficits or pay off even a nickel of the country's long-term debt. The US is currently not paying down much, if any, of its current debts; we are only servicing these by borrowing more to pay off the interest.

As previously noted, Congress must by the middle of May raise the debt ceiling to ensure the US government does not for the first time in its history default on payments of accrued interests. The debt ceiling will be raised, again. And it will be raised again and again in future years because of continuing disagreements over certain issues, including whether debts matter (they do but that's, of course, my opinion); whether the country can afford to cut spending at a time of high unemployment and slow economic growth; and exactly how to fill the debt hole — tax hike or a sharp reduction in spending that would involve the extensive reduction in payouts to major entitlement programs, including Social Security and Medicare/Medicaid.

I can't dig deeply here into why this matters to businesses, but high-tech companies that have ignored the issues of rising deficit financing and stretched out long-term debts in the US may one day rue their lack of attention to this problem. The stock market dipped after Standard & Poor's released its report. At the end of trading on Monday, April 18, the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite each fell 1 percent for the day.

That's an ominous warning. The publicly traded companies that make up these indices all caved under pressure from events totally unrelated to their individual operations. The Standard & Poor's threat was a very lame one in my opinion, and yet stocks swooned. Imagine what would happen if Standard & Poor's actually followed through on its threat, or even better/worse, what if the firm actually did what it was supposed to do — take its blinkers off and tells the US government its credit rating must go down several notches?

14 comments on “What a Cut in US Credit Rating Might Do to Business

  1. hwong
    April 18, 2011

    I guess something positive that people can do to take advantage of this dow/ nasdaq drop is to buy stocks at a discounted price tomorrow morning.

  2. mario8a
    April 18, 2011

    Hi

    in USA the average of debt is 47K per adutl, a cut in Credit rating will be nothing but a disaster on the small bussiness segments.

    Regards

  3. Anna Young
    April 18, 2011

    Bolaji, this is definitely worrying, but can you dig deeper and expatiate potential impact this might have on businesses and high tech industries if the US government fails to tackle increase in the United States deficit.

  4. Eldredge
    April 18, 2011

    I don't think there is any question that the government has to make cuts in spending. Would your businesses creditors stand for inaction in such circumstances?

    Note that the S&P rating hinges on the idea that they do not have the confidence that the government will take a responsible enough action in the face of rising debt.

  5. Parser
    April 19, 2011

    I was shocked listening to this message from Standard & Poor’s. Certainly we all knew about the debt and we all know how hard it is for both parties to agree on anything. While each party claims that American people want this and this, they both forget that they were elected by small percentage difference around 50% in absolute count (not electoral votes) therefore they should compromise for both. This debt will affect financial market in the USA and in the world. All the posturing of cutting billions is not going to change a dime in our taxes. The debt ceiling has to be raised or spending cuts would have to be so harsh that no one will be able to survive them economically. We are all alone and Greece, Ireland or Portuguese at least had European Union with strong German economy.

    There is one more aspect of falling dollar value – China. First of all they have the most amount of dollars in their banks and second they always look at as with an aiming sight. 

  6. Parser
    April 19, 2011

    @ Hwong

    Tomorrow morning might be too late, but it is something people make money of.

  7. jbond
    April 19, 2011

    The old adage of “debt doesn't matter” is going to be proven wrong very soon if nothing is put into place to curb spending and reduce debt. People thought this latest recession was a big deal to businesses and individuals. If the U.S. misses a debt payment or starts having creditors knocking on the door, the ramifications will make the recession look like a blip. Businesses, particularly small businesses that rely on tax breaks and possibly government subsidiaries should take a long hard look at this situation and try and get a plan together in case congress can't or won't try to solve the problems.

    The U.S. is no longer that global super power that can just borrow money left and right without needing to explain its self.

     

     

  8. mfbertozzi
    April 19, 2011

    I think everybody is guessing Congress will find soon the way in order to avoid to lose one's head. Going further, current crisis has its signs in the past and I was wondering why only now Govs are trying to look for something doable to stop it. Cut is not a good way if it still lies alone.

  9. DataCrunch
    April 19, 2011

    I agree that the debt ceiling will be raised as the alternative is too disastrous too think of.  Let’s just hope that our elected officials can come up with a viable plan that puts the country on a track to cut debt and raise revenue.

  10. Taimoor Zubar
    April 19, 2011

    I think an interesting figure to note here would be the per capita national debt for an average US citizen. In my opinion the per capita debt for US nationals might be higher than the figure in many developing countries. Besides the overall debt, this figure might also be an indicator of how alarming the situation is.

  11. SunitaT
    April 19, 2011

    Bolaji,

     I agree with you that Standard & Poor's and other sovereign debt rating firms are doing shoddy job. What in your opinion is the reason for this ? Are they under pressure from US government or they failed to read the situation ?

  12. bolaji ojo
    April 19, 2011

    The credit rating business is not all black and white whether in the sovereign (nations) or corporate (businesses) sides. The same companies and nations that are rated often pay the rating agencies so there is an inherent contradiction in obligations. Are the rating agencies representing the companies they rate or the users of the rating information.

    In the case of nations, I doubt it was easy for Standard & Poor's to even announce it could lower the credit rating of the United States. That must have been a major decision for them and I can only imagine the discussions in-house before the announcement. Also, it's highly likely they informed the US government first and you can bet some pressure would have been applied to ensure the action was not taken.

    A ratings downgrade will hurt not just the US government but also businesses. However, if you read the profile the US currently has without knowing the rating was about the country, you would have to wonder why it has a AAA rating in the first place. The US is indeed a special country — it is the biggest global economy and the currency is still the main currency for international transactions — so its rating is therefore somewhat different than for other nations.

  13. bolaji ojo
    April 19, 2011

    Matteo, Exactly. This is not a new problem and a ratings downgrade warning only puts a bold face on something everyone knew. This problem will take some time to resolve but perhaps the Standard & Poor's warning will finally get people working on it.

  14. hwong
    April 19, 2011

    @parser

    See,  the dow and nasdaq both went up pretty nicely today  🙂

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