The Wall Street Journal
By: Damian Paletta & E.S. Browning
April 19, 2011
S&P Signals Top Credit Rating Is in Danger, Stoking Political Battle on Deficit.
A blunt warning Monday from a credit-rating firm about the U.S. government's mounting debt pushed stock markets lower and intensified political divisions in Washington about how best to tackle growing deficits.
Both the Obama administration and House Republicans scrambled to gain leverage from Standard & Poor's changing its outlook on U.S. Treasury securities to "negative" from "stable."
S&P didn't lower its top-notch AAA-bond rating for U.S. government Treasury securities, and their prices initially fell but later rebounded amid optimism that the report could serve as a catalyst to force both sides in Washington to compromise.
Comparing Debt Ratios
Here's a look at S&P's credit rating and outlook among advanced economies and emerging economies, as well each nation's debt-to-GDP ratio, starting in 2006 and projected through 2016.
The Dow Jones Industrial Average fell 140.24 points, or 1.14%, to 12201.59, its biggest decline in a month, after earlier tumbling almost 250 points. Stocks in Britain, Germany and France fell more than 2%, with most of the declines coming after the S&P news, and in early trading Tuesday, Japan shares fell 1%. Gold surged to just below $1,500 an ounce.
But hopes that the report might spur a deficit deal actually helped U.S. borrowing costs and the dollar. The 10-year Treasury note rose 9/32 in price, pushing its yield down to 3.373%, its lowest 3:00 p.m. level since March 23. The dollar rose against the euro.
A downgrade would push up interest rates on Treasurys, which are a benchmark for other consumer and business borrowing rates, raising the cost of credit throughout the economy.
S&P also revised its outlook on five big U.S. insurance groups that currently are rated AAA, to negative from stable. S&P said the five U.S.-focused insurers "are constrained by the sovereign rating on the U.S."
The insurers are Knights of Columbus, New York Life Insurance Co., Northwestern Mutual Life Insurance Co., Teachers Insurance & Annuity Assoc. of America and United Services Automobile Association. New York Life said its financial and business strength justified continued triple-A ratings. USAA noted that S&P maintained the insurer's AAA credit and financial strength ratings. And Northwestern Mutual said it remains "confident in the strength of our business model." The others couldn't immediately be reached for comment.
Japan, meanwhile, expressed confidence in U.S. government debt. "We continue to believe that U.S. Treasurys are an attractive product for us," said Finance Minister Yoshihiko Noda.
The S&P report questioned whether the White House and Republicans would be able to reach an agreement before the 2012 presidential elections on a plan to rein in deficits. "The sign of political gridlock was a key determinant in our outlook change," said John Chambers, chairman of the sovereign ratings committee at Standard & Poor's Ratings Services.
This year's budget deficit is projected to rise to between $1.5 trillion and $1.65 trillion, equal to roughly 10% of America's gross domestic product, or total economic output. The White House is hoping to form a group of Democratic and Republican lawmakers to craft a framework for reducing the deficit, but has made little progress. Vice President Joe Biden plans to host the group's first meeting May 5.
Treasury Secretary Timothy Geithner has warned lawmakers that their reluctance to raise the federal borrowing limit could cripple the recovery, and the jittery reaction to the S&P report could underscore his arguments about how badly markets would react to any failure to raise the debt ceiling.
The U.S. debt now stands at $14.219 trillion--just shy of the $14.294 trillion cap--and is expected to balloon in part because of rising costs for health care, retirement and other so-called entitlement programs, and the interest on existing debt.
If no action is taken, the government could default on its debt by July 8. Wall Street executives have called Capitol Hill with increasing frequency in recent weeks, urging it to raise the debt ceiling immediately.
Although S&P said it changed its outlook even while assuming the debt ceiling will be increased, many Republicans cited the report in affirming their position that they would raise it only in exchange for a commitment to address the deficit.
"As S&P made clear, getting spending and our deficit under control can no longer be put off for another day, which is why House Republicans will only move forward on the President's request to increase the debt limit if it is accompanied by serious reforms that immediately reduce federal spending and end the culture of debt in Washington," said House Majority Leader Eric Cantor (R., Va.).
White House and Treasury Department officials, who were alerted to the report on Friday, questioned its conclusions but said it validated their efforts to broker a bipartisan deal to address the debt. Administration officials had sensed the downgrade was coming for weeks, and informed President Barack Obama about the change over the weekend.
"Any call for a bipartisan agreement on deficit reduction, on fiscal reform, is a welcome one, and in that context, I think that it adds to what we believe is some momentum towards that end," said White House spokesman Jay Carney.
The move to a negative outlook means S&P believes there is a one-in-three chance that Treasury bonds could be downgraded from their AAA rating, the ratings agency said. Mr. Chambers said outlooks cover a period of six months to two years, during which the credit-rating agency monitors whether the government is moving toward resolving the situation.
Moody's, another U.S. ratings firm, came to a different conclusion in its Weekly Credit Outlook. It called the changed parameters of the debate a turning point.
Since S&P began assigning outlooks to government debt in 1989, five AAA-rated countries have been assigned negative outlooks, including Britain in 2009. Three were subsequently downgraded, and Britain and one other were returned to a stable outlook. S&P acted after it determined that new British austerity measures to cut spending and raise revenue would reduce the government deficit to 3% of GDP by 2014 from 11.2% in 2009.
If the U.S. reaches a British-style resolution, S&P will restore the U.S. outlook to stable, Mr. Chambers said.
The White House last week proposed reducing the deficit at a moderate pace through a combination of tax increases, changes to Medicare and cuts in military and other spending. Republicans have called for quicker action, with bigger cuts in spending and overhauls of Medicare and Medicaid.
S&P said the difference was stark. "We see the path to agreement as challenging because the gap between the parties remains wide," the report said.
Bill Gross, a founder of Pacific Investment Management Co., manager of the world's biggest bond fund, dumped government-related holdings in February and began shorting them in March. He said the S&P action "is one warning shot at least to investors that should be loud and clear in Washington."
--Mary Pilon, Carol E. Lee and Leslie Scism contributed to this article.