5 Reasons The U.S. May See Another Debt Downgrade

By Tim Parker | November 16, 2011 AAA
5 Reasons The U.S. May See Another Debt Downgrade

You've probably never heard the name Ethan Harris, but he's making big news this week. Ethan Harris works for Bank of America/Merrill Lynch as an economist. Recently, he wrote a note to investors saying that it was likely that the United States would see another downgrade of its credit rating. He cited one main reason for the possible downgrade, but there may be a few more.

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Harris' Reason
Harris believes that the Congressional super committee formed to reign in the nation's budgetary problems, is going to end in gridlock. This bipartisan committee has received a flood of ideas, but many believe that the job is too large for a small committee to tackle. As Harris says, "The not-so-super deficit commission is very unlikely to come up with a credible deficit-reduction plan."

Don't Play Well Together
Political bickering is out of control, according to even the politicians. U.S. Senator Scott Brown said recently, "political gamesmanship and gridlock" had to stop. As one side blames the other, nothing gets done and according to recent polling data, Americans are fed up with it. Standard & Poor's downgraded the U.S. credit rating in July and cited this as one of the reasons.

Prior Warnings
In July, when the United States was on the brink of default, Moody's placed the rating on watch saying, "The review of the U.S. government's bond rating is prompted by the possibility that the debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes." The debt limit may not be the reason this time around, but it is clear that the ratings agencies see a direct link between a negative political climate and the nation's ability to repay debt. (For related reading, see A Brief History Of Credit Rating Agencies.)

No New Taxes
Election season is in full swing and that means that taxes won't be raised, any time soon. So far the only thing that the super committee has agreed to, is no new taxes as a result of budgetary changes. That might be the prudent choice in an election season, but for balancing a budget, low taxes in the face of such a large budget deficit, will surely not reinforce the country's future ability to meet its debt obligations.

Questionable New Plans
Standard and Poor's warned, in their initial downgrade, that a further downgrade was possible if "higher general government debt trajectory than we currently assume in our base case" took place. In other words, if things get worse at a faster rate than they assumed, the rating may be cut again.

Republican candidates have released two plans, based on a flat tax system. The most recent plan from presidential candidate Rick Perry would result in "substantial" decreases in tax revenue, according to Ted Gayer, the co-director of the Economic Studies program and a Senior Fellow at the Brookings Institution. Any system that would reduce tax revenues, in the face of an overwhelming debt load, would could qualify as a worsening trajectory.

The Bottom Line
It's important to note that although Standard and Poor's already downgraded the United States' debt rating, the other two major ratings agencies have not. The Bank of America/Merrill Lynch prediction doesn't call for S&P to downgrade the United States again. Instead, Harris believes that at least one of the other two ratings agencies may follow suit, possibly before the end of 2011. (For related reading, see The Debt Ratings Debate.)

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