Why Ratings Firms Are Still Mulling a U.S. Credit Downgrade

The $2.1 trillion of cuts in the current deal is not what S&P wanted

This morning, U.S. stocks fell sharply on news that ratings firms may still downgrade U.S. government credit, wiping out earlier gains on news that the White House and congressional leaders struck a deal on raising the nation's debt ceiling. Wasn't a workable plan to raise the debt ceiling supposed to prevent a downgrade? Well, the problem is ratings firm Standard & Poor's recommended a $4 trillion debt-reduction plan, which the current plan falls well short of (the CBO estimates it would save about $2.1 trillion). But financial analysts question whether the S&P has backed itself in a corner with its $4 trillion plan and if a downgrade to the country's AAA rating would be an inaccurate assessment.

Here's what analysts and ratings agencies are saying:

S&P has backed itself against a wall  "People are still looking at the fact that we have a lot of problems ahead of us," Doreen Mogavero, chief executive of Mogavero, Lee & Co, tells The Wall Street Journal. "People are saying that the language Standard & Poor's has been putting out almost requires them to give us a downgrade of some kind. That's something people have to worry about."

It should've been a $4 trillion deal  “A grand bargain of that nature would signal the seriousness of policy makers to address the fiscal situation in the U.S.,” John Chambers, chairman of S&P’s sovereign rating committee, said on July 28. Anything less would jeopardize the country's rating, he said. Carl Kaufman, who manages almost $2 billion at Osteweis Strategic Income told Reuters the rationale behind Chambers's thinking. "People are waking up to the fact that this isn't a great deal," he said. "It doesn't help the economy, and if we have a continued slowdown the deficit will be larger." Meanwhile, the Moody's ratings agency was less demanding saying "the U.S. should be able to keep its Aaa rating as long as the Treasury agrees to raise the debt ceiling," reports Bloomberg.

A downgrade doesn't make sense “There is no other country that can step in and replace the U.S. at the core of the system,” Mohamed El-Erian, the chief executive officer at Pacific Investment Management Co., manager of the biggest bond fund, told Bloomberg. “The U.S. is the supplier of the reserve currency.” Carl Lantz, the head of interest-rate strategy at Credit Suisse Group, agrees. “It’s hard to imagine that anything is lower risk than Treasuries, whatever S&P says. We’re an economic and military superpower, we are the reserve currency. It’s still as close as you get to a risk-free asset.”