By prodding Washington to agree on a debt plan, Standard & Poor’s might achieve just the opposite. Its dour take on Treasuries could inflame the debt-ceiling debate, leaving little energy for a grand budget compromise. And the severe austerity S&P desires would have few takers anyway. Consider the following:
1) Obviously the rating agency hopes its unnerving note will nudge lawmakers into reaching agreement on taxes and expenditures. Inaction until after the 2012 national elections risks an actual downgrade of America’s AAA bond rating.
2) But striking some mega-deal doesn’t have top priority on Capitol Hill. First up is the battle over raising the debt ceiling. Democrats want a clean vote on a bill, while Republicans are trying to tack on various debt reduction measures. The GOP quickly pointed to S&P’s statement as further justification of its bargaining position.
3) That the rating agency made no mention of the debt ceiling is irrelevant. Nor does it matter that Congress just released a report blaming S&P and its peers for triggering the financial crisis. Politicians take their friends where they can find them. And S&P’s warning is spurring Republicans to dig in. That helps ensure the negotiations will be arduous, requiring Capitol Hill’s nearly undivided attention until July and potentially pushing the country to the brink of default. There probably won’t be much chance to work on major changes to taxing and spending.
4) Such efforts didn’t have much momentum anyway. A bipartisan “Gang of Six” in the Senate is working on a proposal that draws on recommendations from the president’s debt panel. And it was gaining support among Republicans until House Budget Chairman Paul Ryan released his plan.
5) Even if Congress moves toward compromise, making S&P happy won’t be easy. A key metric for the firm is the ratio of net interest payments to government revenue. Goldman Sachs found that all the major reform plans would still allow that ratio to increase to levels that rating agencies would probably consider worrisome. Avoiding that would require defense cuts, immediate cuts to senior benefits and/or tax increases. Good luck with that.
Given the acrimony, if S&P really wants Washington to act, it may find it actually takes more than a warning.