‘Kicking the can’ threatens credit rating

Kicking the can down the road — a great Washington tradition when the two major political parties reach a budget impasse — is not an option this time if the U.S. is to maintain its privileged financial standing in the world.

Even passing an immediate increase in the nation’s debt limit in time to prevent a technical default would not suffice at this point to prevent an economically destabilizing and potentially humiliating downgrade of the U.S. credit rating from AAA to AA, according to Standard & Poor’s Corp.

Nothing less than an ambitious plan to cut future deficits by at least $4 trillion — the so-called grand bargain that has eluded White House and congressional negotiators — will satisfy Wall Street’s oldest credit agency, according to an announcement late last week that already is causing an upheaval in global credit markets and political circles.

S&P is giving the administration and legislators 90 days to come up with a convincing $4 trillion plan that it views as the minimum necessary to stabilize the nation’s burgeoning debt. Otherwise it will lower the boom on a perfect credit rating that has been the world’s benchmark for 70 years.

Global investors increasingly agree with the agency’s assessment that the two U.S. political parties remain so far apart that an agreement on anything more than minimal spending cuts in the $1 trillion range seems unlikely.

“It would be a mistake to dismiss the latest S&P announcement as another warning that can be mostly ignored,” said Ajay Rajadhyaksha, analyst at Barclays Capital, who has been “surprised at the aggressiveness” of the ratings agencies though many investors and Washington politicos seem to have grown inured to their repeated warnings this year. Global credit markets are starting to brace for a downgrade, he said.

Despite behind-the-scenes protests from the White House and Treasury, “the rating agencies have recently shown that they are prepared to take actions that upset local authorities,” he said. He noted that S&P and Moody’s Investors Service — the two biggest Wall Street agencies — have already ruffled feathers this year in Greece, Germany, and other European countries that are also struggling with debt.

“A downgrade of the U.S. by a U.S.-based rating agency is a very real possibility,” he said, despite the agencies’ forbearance with past politicking over legislation raising the debt limit, in deference to the nation’s history of generally managing its finances well through wars, recessions and other emergencies.

What worries S&P and many on Wall Street is this time around, the explosion of debt from already high levels before the recession has the potential to carry the U.S. to the brink of insolvency. Yet political divisions remain so entrenched that the looming crisis has failed to motivate Congress and the White House to reach a compromise on the budget.

“The reality is that any solution to U.S. debt problems will require a disciplined plan to both cut entitlement spending and raise taxes over a number of years,” said David Kelly, chief market strategist at J.P. Morgan Funds. “The problem is,” he said, “politicians are not explaining these realities to the voters.”

While President Obama and some in Congress still hold out the possibility of reaching a major compromise that will satisfy the credit raters, Senate leaders are working on a more limited solution that will enable the president to raise the debt limit by $2.5 trillion in the next year while creating a process to vote separately on politically divisive spending cuts and tax increases.

Since the president has been the leading proponent of a grand bargain recently, some say S&P’s action has strengthened his hand, putting pressure on his congressional opponents to soften their hard stance against raising taxes.

“This has become the loaded gun in Barack Obamas hand,” said Bill Wilson, president of Americans for Limited Government.

But Hank Cox, former president of the National Association of Manufacturers, said Mr. Obama’s embrace of the grand bargain a month ago came too late.

“President Obamas big mistake was not embracing the recommendations of the Simpson-Bowles report last December,” he said, referring to a panel Mr. Obama set up that provided a $4 trillion deficit reduction blueprint like the one he is now endorsing.

“Had he got behind his own commission then, he might have been able to build up some momentum for dramatic action now,” said Mr. Cox. “But the moment for dramatic reform like the presidents $4 trillion budget reduction scheme has passed. Positions have hardened. The best we can hope for now is a much more modest plan to get us past the present crisis and — yes — kick the real issue down the road a bit further.”