Tea Leaf: Debt explosion has nation playing chicken with S&P

Recent issues of this newsletter have pointed out that Congressional skirmishes of prior weeks to keep government open were in fact minor league when compared to what was coming in May. The larger battle is about to begin.

The Congress, with administration support, must increase the debt ceiling, this nation's ability to borrow even more money to fund those reckless budget deficits. What has made the impending battle more interesting in recent days has been a potential downgrade of this nation's credit rating. Just imagine.

Standard & Poor's (S&P), one of the top three credit rating agencies in the nation (and arguably the world), placed the U.S. on "negative outlook," meaning it could be downgraded if the U.S. doesn't soon get a handle on government deficits. "We believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years," noted S&P.

S&P tarnish

S&P is not held in the highest regard in many circles. Numerous critics point out that S&P, along with other major credit rating agencies, placed their AAA rating on billions of dollars in sub-prime mortgage bonds prior to and during the financial crisis that quickly turned sour, according to bloomberg.com. Nevertheless, the idea that the credit rating of the world's richest and most powerful nation could be reduced should be a slap in the face — a wake-up call — to all of us, particularly those in the nation's capital.

Following the S&P shocker, Treasury Secretary Geithner said there was "no risk of that." Similar statements were made by government officials in Greece, Ireland and now Portugal during the past 12-15 months, before each eventually needed (or will get) massive financial bailouts.

The debt explosion

The gross U.S. national debt (including that held by government trust funds including Social Security) was $9 trillion in late 2007, just before the financial roof fell in. Given trillion-dollar-plus budget deficits of recent years, it will reach the current borrowing limit of $14.3 trillion by May 16. Internal juggling by the Treasury Department could keep government bills paid until early July.

At that point a potential, if temporary, default by the U.S. could occur. The ramifications would be immense. U.S. borrowing costs in coming years would rise as the default issue remains on the horizon. In turn, borrowing costs of all U.S. corporations and individuals would rise. Another financial crisis could be triggered. Federal Reserve Chairman Ben Bernanke calls a possible failure to raise the debt limit "a recovery-ending event."

Gerald Seib of The Wall Street Journal discussed "The Politics of the Debt Ceiling" in a recent issue. It is worth reading and notes the childish behavior of our elected officials during prior debt ceiling votes, which (unfortunately) occur almost annually.

The entitlements

Why a major issue this time around the borrowing track? Because the Republican House of Representatives leadership has indicated it will not support a borrowing increase without major progress in reducing future government spending growth rates. House Speaker Boehner notes that this discussion is now about "trillions rather than billions" of dollars.

There is no question that major success in slowing the growth rate of future government spending, particularly in the entitlement area, is mandatory. There is simply no way around it.

Hopefully, solid agreements will be reached. Hopefully, the debt ceiling will be boosted. Another financial crisis must be avoided. Hopefully, politicians can use the S&P statement as "political cover" to reach critical spending agreements so vital to this nation's future.

Jeff Thredgold is the chief economist for Zions Bank and founder of Thredgold Economic Associates, a professional speaking and economic consulting firm. Visit www.thredgold.com.