Fri July 15, 2011
What Happens If U.S. Bond Ratings Are Downgraded?
Ratings agencies Standard & Poor's and Moody's both have warned that they might downgrade the United States' AAA bond rating if a deal between the White House and Congress on raising the debt ceiling isn't reached before an Aug. 2 deadline. NPR asked a trio of economists what it would mean if the bonds were downgraded. The economists are Edwin Truman, a senior fellow at the Peterson Institute for International Economics in Washington; Gregory Dago, principal U.S. economist for Colorado-based IHS/Global Insight; and Mark Weisbrot, co-director of the Center for Economic and Policy Research in Washington.
If the credit rating agencies downgraded the U.S., what would be the immediate impact?
Truman: If there is a default in some form, there would be a tendency for interest costs and credit costs and other costs of the government doing business to rise. In some sense, the credit rating agencies' downgrade would just be a reflection of that. It also raises some questions about the quality of the credit going forward, even if the situation is cured.
Dago: The general impact would be negative for the U.S., which has enjoyed a AAA bond rating from Standard & Poor's for 70 years. We would see an increase in the yields and thus an increase in the borrowing costs throughout the markets. There would be a lot of volatility and uncertainty, but the general movement of yields would be up.
Weisbrot: I'm not sure it would have any impact. When you look at the bond market — 10-year U.S. treasuries, for example — where is it today? In the light of all this hype about debt ceilings and possible defaults, it's at 2.93 today, so this is an extremely low interest rate in both nominal and real terms. It means that everyone in the world is willing to hold these bonds and is not the least bit worried about the possibility of a default. So, investors haven't changed their view of the creditworthiness of the United States at all, and I don't think they're likely to in the foreseeable future.
Specifically, how would it affect Wall Street and global markets?
Dago: There would be a big psychological impact in the sense that the U.S. has generally been considered a safe haven for investors, and if the traditional safe haven suddenly decides that it is unable to finance its debt, it would have dramatic consequences not only in the U.S., but also in the global markets.
Weisbrot: Well, you never know. Markets can be irrational. It's like what [John Maynard] Keynes said — they're looking at what other investors might think, instead of what they themselves think. And they might think other investors are really stupid and actually believe that there's some reason to think that the United States could default on its debt. With that proviso, I think you're much more likely to see what you're seeing now, which is that the bond markets are completely ignoring all of this discussion –- as they should — because the probability of a default on the U.S. debt has not increased from where it was two years, five years, 10 years or 50 years ago.
Truman: It's very unpredictable what would happen, but I'm confident it would not be good, just because the complexities of doing business would be increased. So, they will say 'if the United States can default on its debt, any country can default on its debt.' Therefore, the cost of borrowing for Canada, Japan, as well as Thailand and Mexico goes up. But one needs to distinguish between what is a technical thing –- if the Treasury can't get its checks out on Aug. 2 or 3, but the problem is fixed by Aug. 4, well, that probably will be nothing. It will have a lingering effect on the markets, but I think it will be largely nothing in terms of the overall U.S. and global financial system.
In the case of a downgrade, what would it take to recover a AAA rating from the agencies and how soon could that happen?
Truman: It could happen very quickly, especially if it was only a technical matter. But if the Congress and the administration just kick the ball down the road and don't do anything about our medium-term fiscal situation, then that would also have implications for the long-term credit rating of the United States.
Weisbrot: You'd have to ask the credit rating agencies on that, because what they are doing doesn't really make sense from an economic point of view. So, it's really a question of their politics. They're intervening in a political sense. They are intervening in the debate, politically.
Dago: I personally think a downgrade would be temporary and very short term. The reason for that is that if, unfortunately, we go beyond this debt-ceiling limit, there will be tremendous pressure on politicians from both sides of the aisle to increase the debt ceiling once we've reached it. So, I think as soon as we've raised that debt ceiling, the credit rating agencies would revert back to a AAA bond rating.
Why should we even care what the credit rating agencies have to say considering how wrong they have proven to be in the recent past?
Weisbrot: It's clear they are not a reliable source of information. These are the same credit rating agencies that gave AAA ratings to mortgage-backed securities that turned out to be almost worthless in some cases and enormously overrated in other cases. They were as wrong as you could possibly be and wrong in a way that anybody who could do arithmetic could see was wrong at the time. So, why should we take them seriously?
Dago: Credit rating agencies are the benchmark in terms of the relative risk of specific sovereign bonds.
Truman: (laughs) You see this more in Europe than in the United States. They criticize the credit ratings. Every time Greece is downgraded, Ireland is downgraded or Portugal is downgraded, officials come out and say 'they don't know what they're doing, there ought to be some rule that you can't downgrade a country in the middle of an international support program. On the other hand, they turn around and say 'we only accept as collateral assets of a certain quality.' The fact that they're cursing the credit rating agencies on the one hand and then kowing to them on the other hand would be amusing if it weren't so serious.