Agencies warn politicians: 
Credit ratings on the line

Wall Street ratings agencies are skeptical of the resolve of political leaders to tame the nation’s debts, and are raising the likelihood that at least one of the three top agencies will add to the turmoil in financial markets at the end of the year by further downgrading the U.S. credit rating.

All three agencies have said since Election Day that they are following closely the negotiations over the “fiscal cliff,” and whether the U.S. retains its top AAA rating from two out of the three — or gets downgraded further — depends on the White House and congressional leaders pushing through a major budget deal with $4 trillion or more in savings to stabilize the debt.

President Obama and House Speaker John A. Boehner, Ohio Republican, have pledged to work toward forging such a deal, but they remain far apart on the mix of tax increases and spending reforms needed to get there. Mr. Obama insists he has a mandate to allow the tax rate on top earners to revert to 1990s levels at the end of the year, while Mr. Boehner says conservative Republicans will defeat higher tax rates in the House. The two sides also are severely divided on how to reform Medicare, Medicaid and other entitlement programs to bring down costs as the nation’s population ages.

Any ratings cut by a second Wall Street agency after last year’s first-ever downgrade of the U.S. rating by Standard & Poor’s Corp. has the potential to disrupt financial markets even more than the first downgrade, analysts say, because it would render U.S. Treasury securities ineligible to be included in some investment funds that are required to maintain an average AAA rating on their holdings.

Avoiding such a disruptive ratings cut will not be easy, as the credit agencies are setting high hurdles for Congress and the administration. The second-largest agency, Moody’s Investors Service, for example, says it will downgrade the U.S. rating if Congress and the president “punt” the year-end deadline for imposing $500 billion in tax increases and spending cuts into next year ­— unless in extending the deadline they also agree to finish work next year on a broader budget deal to stabilize the debt.

Moody’s and Fitch Ratings warn that anything short of a major budget accord will lead to a downgrade. But perhaps the most skeptical of all is S&P, which is threatening to further downgrade the U.S. from its AA+ level if Congress and the administration even engage in the kind of cliffhanger politicking they did last year when they came close to driving the Treasury into default on the debt. Observers expect another round of dramatic ultimatums and grandstanding as the deadline approaches.

The uncompromising positions taken by both parties at the start of negotiations have unnerved Wall Street investors, with the stock market taking another dive Wednesday on fears that the warring parties will drive the economy over the fiscal cliff early next year. The Dow Jones industrial average lost another 185.23 points, or 1.45 percent, and ended at 12,570.95.

The financial turmoil will only deepen if the U.S. rating is downgraded again, analysts say. Last year’s downgrade by S&P precipitated a drop of more than 600 points in the Dow.

The 2011 downgrade was “motivated by the trajectory of U.S. public finances and by the political brinkmanship” of Congress and the White House over the debt limit, said S&P Chairman John Chambers, adding that today’s negotiations “give policymakers an opportunity to address both of those credit weaknesses” and prove they can act responsibly.

Mr. Chambers said it will take both tax increases and reforms in the big entitlement programs — Medicare, Medicaid and Social Security — to solve the debt problem. But coming to such a deal is likely to be difficult in the current political atmosphere, he said.

“We continue to see risks that a grand bargain may prove elusive and debate over the fiscal cliff may be as invidious as what we observed in the summer of 2011,” he said.

Moody’s is more focused on the outcome of the negotiations than how the two sides get there, but Moody’s officials also are concerned that politics could get in the way of securing a deal that is good for the economy and for the U.S. credit rating.

“The political landscape remains highly polarized and unpredictable,” said Steven A. Hess, Moody’s senior vice president. “The divided popular vote provides fertile ground for perpetuating the intense political posturing that marked the pre-election period. The statutory debt limit is also likely to be reached around the end of this year, presenting another catalyst for vehement dissonance, and adding to the uncertainties that weigh on investor confidence.”

Fitch said it will downgrade the U.S. rating if the gridlock remains so severe that lawmakers can’t even come to a temporary agreement to forestall abrupt tax increases and spending cuts on Jan. 1. Such a scenario “would mean that the general election had not resolved the political gridlock in Washington” even though the elections “underscored the broad political and public recognition of the importance of addressing the federal government deficit and stabilizing government debt,” Fitch said in a statement the day after the elections.

Maya MacGuineas, president of the Committee for a Responsible Federal Budget, said she is optimistic that the White House and congressional leaders are heeding the warnings. She noted that the leaders of both parties in both houses of Congress issued conciliatory statements shortly after the Fitch announcement.

Berkshire Hathaway CEO Warren Buffett, in an interview on CNN Wednesday, sounded hopeful: “If 25 Republicans put country before party, we won’t go over the fiscal cliff.” Even if there’s no deal, the billionaire investor predicted the impact would be manageable. “[If Congress] can’t get along for the month of January, it’s not going to torpedo the economy.”

But many businessmen and Wall Street investors remain as skeptical — and as worried — as the ratings agencies.

“Avoiding the fiscal cliff will require the kind of political leadership we haven’t seen,” said Reto Gallati, chief investment officer at Raetia Investments. But kicking the can down the road is no longer an option. “The stakes are too high to fail,” he said.