Thu, June 30, 2011
S&P Promises to Give US Debt a “D” If Payments Are Late
Bloomberg TV interviewed John Chambers, managing director of sovereign ratings at S&P, on the consequences of a US default. While he made it clear that the mere act of failing to raise the debt ceiling would not automatically cause a rating change, he made it clear that if any debt payment were not made on time, S&P would change the Treasury’s rating from AAA to D.
Default, from the point of view of a ratings agency, is not necessarily the same as a failure to raise the debt ceiling on time. Some Republican congressmen have argued that the Treasury could prioritize creditor repayments even without an increase in the debt ceiling, thus avoiding a sovereign default.
The consequences of a US debt downgrade would be dramatic – in order to reflect the increased risk, interest rates on US sovereign debt would have to rise suddenly and significantly, increasing the cost of future borrowing and causing the value of existing Treasury bonds to drop. Such an event would reverberate quickly throughout world financial markets. But Chambers stated that the chances of a default are small. Congress has a history of raising the debt ceiling at the last possible moment in order to avoid trouble. It seems unlikely, in fact, that anyone would be willing to take the blame for the consequences of an actual default – but that doesn’t guarantee that it could not happen.
According to the Treasury, the debt ceiling must be raised by August 2nd. Technically, the debt limit was reached in May, but for now the Treasury has been doing a juggling act, suspending payments into the Civil Service investment fund and shuffling other obligations around in order to stay technically in the black.
Paying off Federal debts selectively – giving debt repayment priority over other Federal spending – would require an overnight massive contraction of other government spending and would be “disruptive” to the economy, according to Chambers. The Treasury has indicated that such a strategy would require slashing all government payments by 40%. Presumably, that would include things like Social Security, Medicare, and government employee paychecks. Even such a “selective” default approach would be quite messy. Let’s hope we don’t find out what one looks like.