James Pethokoukis

Politics and policy from inside Washington

The impact of U.S. credit rating downgrade

Jul 20, 2011 17:22 UTC

It does not appear to be as frightening as I might have assumed. Here is a bit (via Business Insider) from a Goldman Sachs conference call this morning where the impact of a AAA downgrade is discussed

11:23 It has to do with the magnitude of the downgrade. If we went to AA, directionally it would be negative but it’s suprising the modest effect it could have on, IE:

– Money market mutual funds are front of mind when thinking about a downgrade. Reqired to hold 97% of their assets in AAA

In terms of the rating that matters – it’s the short-term rating, not the long-term rating. And the S&P has implied that it would only downgrade the long-term, so money market funds wouldn’t be affected. They hold between 300 and 350 billion in treasuries. Probably not as much of a risk

– Financial sector- banks — didn’t want to be too specific, but under Basel I there wouldn’t be any affect. under basel II, 0-risk to anything AA and above, so not really an issue

The complicated factor comes in with some of the larger firms, there could be a slight uptick in the calculated capital required to be set aside related to holdings. But a very minor change in capital requirements

– Insurers – obvious. those three bring the $ up to $1 trillion

– Pension funds – not much of an issue

11:28 Rest of the question becomes what the rest of the world would do, how much selling, but they might have more flexibility than holders in the U.S.

11:31: On august 3rd we have a social security checks due. On August 15, we have a coupon due. The treasury will have to decide what it will do to make those payments

Perhaps the bigger impact will be political if Obama or Republicans get the bulk of the blame for losing America’s gold-plated credit rating.



McBride, your credit works in a similar manner. When you have credit obligations and are paying them, your credit will strengthen. When you stop paying them your credit weakens. Whether you choose to borrow more or not does not impact your credit rating. However, your credit rating will determine how much you are able to borrow. Please make a better effort to understand the current political and economic climates.

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How would U.S. react to a debt crisis?

Jul 20, 2011 17:20 UTC

If the U.S. doesn’t get a handle on federal debt, there will be a financial and economic crisis. By 2035, debt as a share of GDP could be 250 percent, though a panic would surely happen long before that point was reached. But if a crisis came, how would Washington react? What drastic measures would be taken? I think there would be a huge push for a massive tax increase, probably via a value-added tax. Here is some of what the Comeback America Initiative sees happening:

Social Security

• The higher retirement eligibility ages for Social Security would be increased to 70 for normal retirement and 65 for early retirement, and fully implemented by 2030 and 2020, respectively.

Most of the proposed reforms under the Preemptive (Prudent) Framework would be retained with the following significant differences:

• Repeal the Affordable Care Act of 2010.

• Repeal the Medicare Modernization Act of 2003.


Most of the illustrative reforms under the Preemptive (Prudent) Framework would be retained with the following significant differences:

• Accelerate the planned draw down of U.S. troops from Southwest Asia from the end of 2014 to the end of 2012.

• Accelerate the reduction of U.S. overseas military and civilian presence.

Taxes and Revenues:

• Impose temporary deficit reduction revenue increases in fiscal 2013-2014 to accelerate deficit reduction and debt/GDP stabilization efforts.

• Phase-in the special income and payroll tax exclusion on employer provided and paid health care by 2018.

• Take any other actions needed to comply with annual revenue targets.

And the result:

The result is a balancing of the total budget by 2015, and reduction of debt/GDP to about 51 percent of GDP in 2021 and declining rapidly, versus about 76 percent of GDP and increasing rapidly under CBO’s current law baseline, and to about 28 percent and declining in 2035 versus about 91 percent and rising under the baseline.  … Overall spending under the framework would be reduced to 20.1 percent of GDP in 2021, from 23.9 percent under the current law baseline, and to 21.8 percent of GDP and leveling in 2035 from 28.3 percent and rising under the baseline. Nominal public debt would be less in 2023 than 2015 and essentially stable.The Reactive (Crisis Management) Framework also involves having to impose a temporary deficit reduction revenue increases to accelerate deficit reduction and debt/GDP stabilization, while maintaining an overall cap on federal revenues at 21.5 percent of GDP



Re healthcare – As long as we’re in simplification mode, why not simply put the entire US population into a single risk pool? Then let insurance companies compete for customers and the providers to serve them. As it stands, each state sets its own regulations and the result is that insurers play the system by cherry picking markets, charging higher premiums in states where they can get away with it, and dictating how providers are compensated. Tear down the barriers and prices will fall.

The only thing certain about repealing Romneycare and not replacing it with another plan is that healthcare costs will soar off the charts and ever increasing numbers of people will be denied access.

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Americans still think raising debt ceiling a dodgy idea

Jul 20, 2011 14:34 UTC

These results from a survey by Northwestern’s Kellogg School of Management (via its Financial Trust Index site) are sure to get noticed in Washington:

Why the House GOP will deep six the Gang of Six

Jul 20, 2011 13:33 UTC

Will the House GOP play ball on the Gang of Six debt reduction plan? The Paul Ryan-led House Budget Committee is giving members all the ammo they need to take a pass (bold is mine):

Heavy Reliance on Revenues. The plan claims to increase revenues by $1.2 trillion relative to a “plausible baseline.” It also claims to provide $1.5 trillion in tax relief relative to the CBO March baseline. The CBO baseline assumes the expiration of tax relief, resulting in a $3.5 trillion revenue increase. As a result, the plan appears to include a $2 trillion revenue increase relative to a current policy baseline. If the $800 billion in tax increases from the new health care law are included, the plan appears to increase revenues by $2.8 trillion, without addressing unsustainable health care spending that is driving our debt problems.

Elusive Spending Restraint. It is unclear how much the plan achieves in spending savings. Based on released documents, it appears to primarily rely on cuts in the defense budget through $886 billion in reductions from the President’s budget for “security programs.” In the security category the Gang of Six reduced the security category by $886 billion. Department of Defense (DOD) spending comprises approximately 85% of the security category. The Gang of Six also proposes a firewall that requires this $886 billion is cut from security spending.

Lack of Entitlement Reform. The plan does not address the $1.4 trillion in spending expansions in the new health care law. The health care law increases eligibility for the Medicaid program by one-third and creates a brand new health care entitlement. It does not appear to include reforms to the Medicare program. While it appears to pursue Social Security reform, it could end up creating barriers to enactment of these reforms.

I mean, the stunningly massive tax hike alone is a deal killer, I would think. Now there are some parts Team Ryan seems to like, and maybe they could get added to the McConnell-Reid plan, such as repealing the CLASS Act and various budget reforms. But more than that? I doubt it.


I concur Mr. Pethokoukis. If one considers the ordinary baseline is revenues of 18% of GDP, that would translate into about 2.7 trillion dollars. That is 27 trillion over 10 years. Increasing taxes by 2.8 trillion dollars means an increase of over 10% of all federal tax collections. That is an enormous tax increase in times of good economy and probably a disastrous increase in times of bad economic news. Gallup just came out yesterday with news unemployment in creased in the first half of July. If that persists it means unemployment in early August will increase. Another potential problem few people realize is that the extra 280 billion dollars will probably not come from the “rich”. Recall the expiration of the tax cuts is thought to bring only 70 billion dollars a year. Either we will soak them by increasing their rate not by 4.6% but rather 18.4% or there will be tax increases for all the 53% of people who indeed pay income taxes or a massive increase in corporate taxes.

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