America’s triple A rating is at risk - FT Article
Started May 13 2009 at 7:50AM (EST) (By victor)
America’s triple A rating is at risk
By David Walker
Published: May 12 2009 20:06 | Last updated: May 12 2009 20:06
Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.
That warning from Moody’s focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we’re in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.
Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the People’s Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.
The US, despite the downturn, has the resources, expertise and resilience to restore its economy and meet its obligations. Moreover, many of the trillions of dollars recently funnelled into the financial system will hopefully rescue it and stimulate our economy.
The US government has had a triple A credit rating since 1917, but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.
First, while comprehensive healthcare reform is needed, it must not further harm our nation’s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.
Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.
For too long, the US has delayed making the tough but necessary choices needed to reverse its deteriorating financial condition. One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate. The credit rating agencies have been wildly wrong before, not least with mortgage-backed securities.
How can one justify bestowing a triple A rating on an entity with an accumulated negative net worth of more than $11,000bn (€8,000bn, £7,000bn) and additional off-balance sheet obligations of $45,000bn? An entity that is set to run a $1,800bn-plus deficit for the current year and trillion dollar-plus deficits for years to come?
I have fought on the front lines of the war for fiscal responsibility for almost six years. We should have been more wary of tax cuts in 2001 without matching spending cuts that would have prevented the budget going deeply into deficit. That mistake was compounded in 2003, when President George W. Bush proposed expanding Medicare to include a prescription drug benefit. We must learn from past mistakes.
Fiscal irresponsibility comes in two primary forms – acts of commission and of omission. Both are in danger of undermining our future.
First, Washington is about to embark on another major healthcare reform debate, this time over the need for comprehensive healthcare reform. The debate is driven, in large part, by the recognition that healthcare costs are the single largest contributor to our nation’s fiscal imbalance. It also recognises that the US is the only large industrialised nation without some level of guaranteed health coverage.
There is no question that this nation needs to pursue comprehensive healthcare reform that should address the important dimensions of coverage, cost, quality and personal responsibility. But while comprehensive reform is called for and some basic level of universal coverage is appropriate, it is critically important that we not shoot ourselves again. Comprehensive healthcare reform should significantly reduce the huge unfunded healthcare promises we already have (over $36,000bn for Medicare alone as of last September), as well as the large and growing structural deficits that threaten our future.
One way out of these problems is for the president and Congress to create a “fiscal future commission” where everything is on the table, including budget controls, entitlement programme reforms and tax increases. This commission should venture beyond Washington’s Beltway to engage the American people, using digital technologies in an unparalleled manner. If it can achieve a predetermined super-majority vote on a package of recommendations, they should be guaranteed a vote in Congress.
Recent research conducted for the Peterson Foundation shows that 90 per cent of Americans want the federal government to put its own financial house in order. It also shows that the public supports the creation of a fiscal commission by a two-to-one margin. Yet Washington still sleeps, and it is clear that we cannot count on politicians to make tough transformational changes on multiple fronts using the regular legislative process. We have to act before we face a much larger economic crisis. Let’s not wait until a credit rating downgrade. The time for Washington to wake up is now.
David Walker is chief executive of the Peter G. Peterson Foundation and former comptroller general of the US
Copyright The Financial Times Limited 2009
By David Walker
Published: May 12 2009 20:06 | Last updated: May 12 2009 20:06
Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.
That warning from Moody’s focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we’re in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.
Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the People’s Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.
The US, despite the downturn, has the resources, expertise and resilience to restore its economy and meet its obligations. Moreover, many of the trillions of dollars recently funnelled into the financial system will hopefully rescue it and stimulate our economy.
The US government has had a triple A credit rating since 1917, but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.
First, while comprehensive healthcare reform is needed, it must not further harm our nation’s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.
Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.
For too long, the US has delayed making the tough but necessary choices needed to reverse its deteriorating financial condition. One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate. The credit rating agencies have been wildly wrong before, not least with mortgage-backed securities.
How can one justify bestowing a triple A rating on an entity with an accumulated negative net worth of more than $11,000bn (€8,000bn, £7,000bn) and additional off-balance sheet obligations of $45,000bn? An entity that is set to run a $1,800bn-plus deficit for the current year and trillion dollar-plus deficits for years to come?
I have fought on the front lines of the war for fiscal responsibility for almost six years. We should have been more wary of tax cuts in 2001 without matching spending cuts that would have prevented the budget going deeply into deficit. That mistake was compounded in 2003, when President George W. Bush proposed expanding Medicare to include a prescription drug benefit. We must learn from past mistakes.
Fiscal irresponsibility comes in two primary forms – acts of commission and of omission. Both are in danger of undermining our future.
First, Washington is about to embark on another major healthcare reform debate, this time over the need for comprehensive healthcare reform. The debate is driven, in large part, by the recognition that healthcare costs are the single largest contributor to our nation’s fiscal imbalance. It also recognises that the US is the only large industrialised nation without some level of guaranteed health coverage.
There is no question that this nation needs to pursue comprehensive healthcare reform that should address the important dimensions of coverage, cost, quality and personal responsibility. But while comprehensive reform is called for and some basic level of universal coverage is appropriate, it is critically important that we not shoot ourselves again. Comprehensive healthcare reform should significantly reduce the huge unfunded healthcare promises we already have (over $36,000bn for Medicare alone as of last September), as well as the large and growing structural deficits that threaten our future.
One way out of these problems is for the president and Congress to create a “fiscal future commission” where everything is on the table, including budget controls, entitlement programme reforms and tax increases. This commission should venture beyond Washington’s Beltway to engage the American people, using digital technologies in an unparalleled manner. If it can achieve a predetermined super-majority vote on a package of recommendations, they should be guaranteed a vote in Congress.
Recent research conducted for the Peterson Foundation shows that 90 per cent of Americans want the federal government to put its own financial house in order. It also shows that the public supports the creation of a fiscal commission by a two-to-one margin. Yet Washington still sleeps, and it is clear that we cannot count on politicians to make tough transformational changes on multiple fronts using the regular legislative process. We have to act before we face a much larger economic crisis. Let’s not wait until a credit rating downgrade. The time for Washington to wake up is now.
David Walker is chief executive of the Peter G. Peterson Foundation and former comptroller general of the US
Copyright The Financial Times Limited 2009
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20 Comments
Top 2%
miller
May 13 2009 at 8:45AM (EST)
Thanks for this great article.. it convinces me that I'm doing well by investing in ETF's - letting other people manage my money for now and stashing aside the dividends.
Top 1%
DowJonesDave
May 13 2009 at 9:23AM (EST)
If the US credit rating takes a hit, things will really get dicey. I've talked about this risk before, and that I expect (and still halfway do, even if it is politically unthinkable) this risk to make itself a frontlie fear soon.
Will teh credit agencies actually downgrade US debt? Can they? I mean could they survive the fallout of such an action? I'm sure the government is telling them not to do it and pressuring against such an action with all the migyt available.
If our rating is downgraded, then u ain't seen nuthin yet as far as downside!
Top 1%
beancounter
May 13 2009 at 10:55AM (EST)
Agreed DJD - Sounds like that portends higher rates, majorly higher rates.
Top 1%
maven100
May 13 2009 at 10:59AM (EST)
this is part of my TBT thesis...but I hope it deosnt happen...dis will be bery bery bad
Top 1%
ellkell
May 14 2009 at 4:09AM (EST)
i think you need to see the economy as an extension of military might. 'the one minute president' is an amazingly funny book that illustrates this. as long as we are the de-facto world cop, ie the 'pax americana' is in place, we are where the fearful will flee too.
Top 1%
V4Vendetta
May 15 2009 at 3:13AM (EST)
Ellkell has got it (and its what Ron Paul and the other goldbugs often miss).
America has the biggest guns and town and lives on an island. Pretty safe investment; comparatively speaking.
Top 79%
Nablus
May 15 2009 at 9:16AM (EST)
Any other country, in the same economic situation, would have lost its AAA rating long ago. The only reason the US still hold the tripleA rating is because it is the US.
Just another sign for the bad quality of the rating agencies...
+ The relative global power of the US is gradualy shrinking, so i bet the 'pax-americana' will not be here in 2030.
Top 1%
DowJonesDave
May 15 2009 at 9:22AM (EST)
I won't be here in 2030 (Unless I live to be 84) ... lol
The older I get the shorter term I think.
Top 79%
Nablus
May 15 2009 at 11:28AM (EST)
a. when i bet i take a wide spread, to be on the safe side. 2030 is 2020+10y safty...
b. your chances to be here in 2030 are above 50% (assumptions: 1.healthy today 2.above average income living in the one of the OECD countries). take into account that we are dealing with conditional probabilities...
;-)
Top 1%
maven100
May 15 2009 at 12:01PM (EST)
nablus - dude, from your comments I gather you really seem to have a problem with america...Yes, US is gradually losing its global power....but ask yourself a question...which nation would you like to see gain at america's expense? China? Russia? France? Saudi's? Iran? WHO?
Be careful what you wish for...a pronounced shift in the balance of power in the world..will be extrmely destabilizing...i am not a die hard patriot, (and I disagree with many us gov't policies) but I see no one else in this world that can necessearily do a better job..as a Superpower.
As far as your comment:
"Any other country, in the same economic situation, would have lost its AAA rating long ago. The only reason the US still hold the tripleA rating is because it is the US"
If any other country that experienced the magnitude of the financial earthquake that we have,it would require some major rescuing from the rest of the the world....(Iceland buckled just from the aftershocks)...at least we are doing most of our own rescueing ourselves...even though we are relying on foreign capital...as DJD is pointing out..just think trough the consequences of US economy collape on the rest of the world. The uninteded consequences of US debt rating cut will be pretty bad for EVERYONE..including your own country.
Top 79%
Nablus
May 15 2009 at 12:55PM (EST)
maven, i am just looking at what is happening. i dont like nor hate the US.
This view seem to US lovers as an anti-US view. but it is not. you are the one who are biased, not me.
why you hold the idea that i wish for US collapse? it is in your imagination.
i think it will be better for me (though not for anybody) to live under US power (like the last 60 years) compared to Russia or China for example. but this is totally irelevant for the global view, when one try to see where are we heading. we should look at what is going on with our eyes open, and to leave our dreams aside.
The US credit rating is meaningless - to me as an investor. if i would take it siriously i would buy US debt. However, i sell it. Means that i think the 'real' rating of the US is lower than the official tripleA rating.
Top 1%
maven100
May 15 2009 at 2:19PM (EST)
yes, I agree with you on US debt being lower quality than the rating is implying- no arguement. But the actual event of the US debt downgrade will be hugely negative for the whole world, along the lines of a 'black swan'.
Top 1%
beancounter
May 15 2009 at 2:49PM (EST)
Maven, I tend to be with Nablus on this one the debt rating is meaningless (so are the credit agencies). Seriously, if any country had just done to the world what we did via CDS, CDOs etc, they'd have been invaded, their government disbanded, and financial personnel executed (or waterboarded.) (I exagerate to make a point, a little.)
And our debt valuations would be like Brazil in the early 90's - worth its weight in toilet paper. It's only because we are who we are that such a scenario did not play out. This is a mess of the US government's making (I'll take side arguments on that one all day.) and we definitely did, and are doing, major damage to our balance sheet long term.
With regard to the dollar, our debt etc. I think there are enough "big" powers out there that like the idea of a check on the US generally and the dollar is one way to do it. (I've been reading a lot of George Soros lately, who for as much as I dislike his politics, he's got the macro global scene pretty much nailed.)
I don't see how the rating agencies (not that they're any good anyway) could not lower our rating and thus raise our rates. A Rate rise has to happen for us to continue to attract capital- with social security, medicare, defense and now just more debt on top via the recovery act, etc. you're practically defying a law of physics and devaluation seems only around the corner, along with tax increases. Not much of a rosy scenario.
Top 1%
V4Vendetta
May 15 2009 at 3:21PM (EST)
Nablus,
You have clearly demonstrated a pretty strong anti-American bias. Which is fine, of course, but you should at least be accountable for your own opinions!
American debt is much like democracy. The worst there is; except for everything else!
Top 1%
DowJonesDave
May 15 2009 at 5:59PM (EST)
The real risk of USA credit downgrade are the number of bond funds and other institutions that are required to hold only AAA rated securities that are in posession of T-Bills.
If the Rating is taken down, most of the above type institutions/funds would be REQUIRED to sell the T-Bill positions. That's the big risk. As bond yields spike,stocks would look less attractive...
etc
Top 1%
beancounter
May 15 2009 at 9:18PM (EST)
Why would it take something 3rd party like a rating to crash bond prices? It seems counterintuitive to me. If the credit is that bad it would be reflected in yields.
And if as you say DJD they were put in a situation where they had to sell, that would most definitely be a disaster.
Top 1%
DowJonesDave
May 16 2009 at 5:34AM (EST)
Bond yields would spike due to the selling of t-bills (price down = Yld up).
Top 1%
beancounter
May 16 2009 at 8:11AM (EST)
Right DJD, but the question is why wouldn't that have happened already, regardless of the rating agencies? (you know, those brilliant guys and gals who brought us AAA rated CDOs that had vapor as underlying collateral.) :-)
Top 1%
maven100
May 16 2009 at 12:06PM (EST)
bean, djd is absolutely correct...many pension plans and sovereign funds can only invest in triple A rated debt instruments...many other investors must have a predefined allocation to triple A...it has nothing to do with what a manager believes the 'true' rating is it what it actually is...
Top 1%
DowJonesDave
May 17 2009 at 7:32AM (EST)
To understand the effect on stocks you need to know about "Total Return" and "Return to Maturity."
Total Return applies to stocks. It is the Earnings Yield Plus the Dividend Yld summed.
So if the Dow has 2% Divs and a PE of 20, then the Total Return yld would be7%.
The Yield to Maturity is what bonds will return based on interest yld plus the redemption value profit/loss.
By comparing these two numbers institutions decide whether to invest in Bonds or stocks.
As bonds decline (assuming downgrade US debt) the Yld to Maturity will rise, and when compared with stocks total return, the decision would be made which area to park money in.
As Bonds decline they will look attractive compared to stocks, which will drive the stock markets down. It would be agreat buying op AFTER the shakeout.