S&P backs off downgrade threat for U.S. government

Standard & Poor’s Corp. on Monday withdrew its threat to downgrade the U.S. government for a second time, citing an improving economy and declining budget deficits. But it said the U.S. still falls short of getting a AAA rating because the two bickering political parties refuse to bridge their differences and address long-term debt problems.

The largest of Wall Street’s credit raters, S&P, precipitated a 600-point drop in the Dow Jones industrial average when it downgraded the U.S. from AAA to AA+ in August 2011. It warned this year about another possible downgrade, given the seeming inability of the two parties to overcome their deeply entrenched views and reach a compromise.

But S&P backed off that threat Monday, issuing a statement saying it was raising the outlook for the U.S. rating from “negative” to “stable.” Congress and the administration were spared a further downgrade largely because of the improving economy, which generated a record surge in revenue in April and huge profits at government-owned Fannie Mae and Freddie Mac that resulted in gigantic cash dividends for the government and dramatically lowered the deficit this year.

Those economic improvements, along with the “blunt” instruments of the across-the-board spending cuts put into place in March and the “fiscal cliff” deal reinstating some taxes at the beginning of the year, led to a much-improved outlook for the deficit, S&P said.

The agency projects deficits will continue to decline to 4 percent of economic output in the next few years and the accumulated debt will stabilize for a while, giving Congress time to address longer-term budget problems such as the eventual insolvency of Social Security and Medicare.

S&P gave political leaders a little credit for the last-minute compromise to avert the “fiscal cliff” on Jan. 1, forged by Vice President Joseph R. Biden and Senate Minority Leader Mitch McConnell, Kentucky Republican. But it found little other evidence of easing the political gridlock.

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“The ability of elected officials to address the country’s medium-term fiscal challenges has decreased in the past decade due to what we consider to be increased partisanship and fundamentally opposing views by the two main political parties on the optimal size of government,” said S&P analyst Nikola G. Swann. “Views also differ on the preferred mix between expenditure and revenue measures in the quest to return the federal budget toward a more balanced position.”

These political differences, which in past eras were overcome from time to time by political leaders in the interest of solving the deficit and other potentially debilitating national problems, continue to fester and tarnish the outstanding economic assets of the United States which otherwise would give it a AAA rating, she said.

U.S. strength is underpinned by a resilient, large and diversified economy bolstered by high incomes and a strong market culture, as well as a credible and effective central bank, the Federal Reserve, which has kept the economic recovery on track despite many difficulties since the Great Recession of 2007-09, S&P said.

The U.S. also benefits like no other country from issuing the world’s reserve currency, the dollar, which allows for free or low-cost loans from banks, investors and citizens around the world, S&P said.

Looking forward, Ms. Swann said a sort of political detente that seems to have developed this year over the debt limit is likely to remain in place and prevent another histrionic standoff and near-default on Treasury debt, as occurred in 2011 when S&P first downgraded the U.S.

“Although we expect some political posturing to coincide with raising the government’s debt ceiling, which now appears likely to occur near the Sept. 30 fiscal year-end, we assume … that the debate will not result in a sudden unplanned contraction in current spending — which could be disruptive — let alone debt service,” she said.

Fitch and Moody’s Investor Service, two other major Wall Street ratings agencies that threatened a downgrade if the U.S. did not reduce its massive debts, have not responded since the Congressional Budget Office dramatically lowered its forecast for U.S. deficits and debt last month. Both agencies this year said they were looking for a comprehensive deal between the parties addressing long-term debt problems such as the burgeoning entitlement programs.

Wall Street celebrated the waning deficit threat when the CBO report was released, lifting stock indexes to record highs. Many global investors and financial analysts are willing to give Washington a little more credit than S&P for making the right moves during the recession and — eventually — going a long way toward slaying the deficit dragon.

“America did a fine job engineering a recovery and handling its economic and financial market crisis,” in contrast to the “lousy job” by Europe, said Lok Sang Ho, an economics professor at Lingnan University in Hong Kong.

The U.S., under the Bush and Obama administrations, moved to prop up companies such as Fannie Mae, Freddie Mac, General Motors Co. and the American International Group Inc., which had made mistakes or were in danger of going bankrupt primarily because of the sharp economic dislocations during the financial crisis in the fall of 2008, he said.

While the bailout of those corporations and banks initially cost a lot of money and helped drive up the budget deficit to unprecedented levels of more than $1 trillion, the moves paid off: Nearly all the institutions rescued are growing and profitable again and have repaid or are repaying their government aid, he said.

“During crises, confidence is weak. The bailouts often acted as ’circuit breakers’ that contained the damage when companies failed,” Mr. Ho said. “When confidence revives, the companies often returned to profit, allowing the government to reap a handsome return.”

People who focus on the mounting government debt during the crisis are fixating on the wrong problem, he said. The government’s job during the crisis was to help the private sector cope with its overwhelming debts, particularly banks and homeowners hit by the collapse of the housing bubble, he said.

Now that the private sector has mended, “the ’cheer-cheer spiral’ dynamics begin to take hold, and the indebtedness of the government sector … can begin to unwind.”