The Corner

Worried About a Downgrade?

According to Politico, today the risk of a downgrade by S&P is what’s scaring the White House and Congress the most, not default.

It’s not the default that strikes the most fear in the White House and Congress these days. It’s the downgrade.

[. . .]

What really haunts the administration is the very real prospect, stoked two weeks ago by Standard & Poor’s, that Barack Obama could go down in history as the president who presided over his country’s loss of its gold-plated, triple-A bond rating. Financial analysts say such a move would hit Americans with more than $100 billion a year in higher borrowing costs, but it’s not just that. It would be a psychic blow to a nation that already looks over its shoulder at rising economic powers like China and wonders, what’s gone wrong? And it would give the president’s Republican rivals a ready-made line of attack that he’s dragging the country in the wrong direction.

While I agree about the potential consequences of a downgrade (it would be expensive), I’m not sure I agree that it’s what the White House and Congress are really worried about. If it were, both sides would be actively trying to address the problems that could lead to a downgrade. It’s not like they don’t know what S&P is looking for in a deal. In fact, S&P’s David Beers was interviewed by Larry Kudlow last night, and after reaffirming that there was a 50 percent possibility of a downgrade if the U.S. doesn’t get its act together, he explained once again what S&P is looking for:

Well, given the continuing political gridlock, I guess what we’re looking for is some [deal] which we think will make a difference over the medium term in slowing the — or if not reversing the rising trajectory of government debt, as, for example, a percentage of GDP.

He specifically added that he would like to see a plan that stabilizes our debt in the short term with a prospect of seeing it fall in the near future. As I have been pointing out for months now, the debt-ceiling debate matters only as a way to focus our attention on the nation’s long-run fiscal outlook, which needs to be dealt with today or at least in the next few months.

Anyone who has looked at the CBO baseline (a rosy projection that assumes that everything passed into law ends up happening) knows that even if lawmakers allow the Bush tax cuts to expire and the AMT to hit as many people as it is scheduled to hit without a patch, and enforce all the savings included in the health-care bill, the debt-to-GDP ratio is still projected to go up quite dramatically.

And this is why I am not sure that lawmakers’ professed concern about a downgrade is genuine. If it were, both sides would be less reluctant to talk about reforming entitlement spending — which is the source of the spending explosion in upcoming years and will remain a problem even if we let the Bush tax cuts expire. If the White House and Congress are so worried about a downgrade, why don’t they stress the need to finally have a conversation about reforming Medicare, Social Security, and Medicaid? I assume that the threat of a downgrade gives lawmakers on both sides some political coverage to talk about fixes like moving the eligibility age for both Medicare and Social Security — which is where the biggest savings are.

Also, while I can see why some might see it as stubborn to refuse to discuss any measures that may increase tax revenue, I can’t see how the absolute refusal to talk about anything that looks like or is a benefit cut isn’t just as stubborn, if not more so considering the downgrade threat. We are not going to address our long-term debt problems without making changes to health-care and retirement spending. We just aren’t. Being worried about a downgrade should mean being willing to talk about reforming entitlements.

I know that many people will argue that politics is what gets in the way of doing what we need to do to avoid a downgrade. I would like to remind them that S&P has also made it clear that politics does get in the way of keeping our AAA rating. So what are we waiting for?

Update: A business reporter at Bloomberg I was just talking with this afternoon told me that lawmakers probably aren’t too worried about a downgrade because “they have done their homework and understand that it would be costly but not devastating and certainly not a run on Treasuries.” Your thoughts?

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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