At the precipice of default, S&P has declared a 50-50 chance of U.S. downgrade. A thought experiment: what would be the risk in doubling the debt ceiling?
This morning, the ratings agency Standard & Poor's said again that there is a 50-50 chance the United States' sterling AAA-credit rating could be cut as soon as August.*
I've read a few writers say, Well, the S&P is just a ratings agency. It was wrong throughout the housing bubble. Who cares what it says today?
Everybody should. Certain funds promise investors to hold a percentage of AAA bonds. If the U.S. loses its AAA-rating, these funds might have to sell off U.S. bonds. The sell-off would drive up interest rates for government debt, which would trickle down into the economy in the form of higher rates for mortgages, car loans, you name it.
The U.S. owns or guarantees more than 90% of all new mortgages, and retirement funds, such as pensions and 401(k)'s, are heavily invested in government-backed securities, as Dan Indiviglio pointed out this week. If our largest banks lose their AAA-ratings as well, we'll have a financial crisis redux at a moment of critical weakness for the player that bailed us out the first time -- the U.S. government.
Threatening to default on our debt isn't just dangerous, it's also irrelevant to the larger question of what to do with spending and taxes in the next ten yeas. The game of chicken in Washington over whether to raise the debt ceiling occasionally veers into topics like spending cuts and tax increases and ten-year savings plans. At the risk of sounding like a broken record: These are important topics to discuss, but they have nothing to do with raising the debt ceiling.
So little, in fact, that I wonder what would happen if we raised the debt ceiling today by $14 trillion without a dime of spending cuts and announced that lawmakers would continue to hammer out a debt deal. I think here's what would probably happen: The stock market would rally on news that we avoided default, borrowing rates would stay near historic lows, the United States could continue to debate various deficit reduction plans, and the S&P would have no cause to issue a downgrade while we continued to discuss fundamental budget reform. I recognize this is a political impossibility today, but I also don't see a downside. The absence of a debt ceiling reduces the chance of default. That should be good for our debt rating and good for market certainty.
What do you think?