07.21.2011 2

Credit Downgrade Would Drag Blue States into Abyss

By Bill Wilson – According to a recent analysis by Reuters’ Steven Johnson and Daniel Bases, a threatened credit rating downgrade of U.S. treasuries by S&P, Moody’s, and Fitch could drag down state and municipal bonds, leading to higher borrowing costs at a time when governments are already strapped for cash.

“All three major ratings agencies have said the top ratings on billions of dollars of pre-refunded municipal debt secured by U.S. Treasuries could fall if the federal rating is cut. More than $130 billion in muni debt is at risk of downgrade from Triple-A, Moody’s said last week,” write Johnson and Bases.

Moody’s has promised to review the federal government for a downgrade should it fail to adopt a fiscal consolidation plan of at least $4 trillion, and S&P sees a 50 percent likelihood of a downgrade in just the next 90 days. Which means there is no time to lose.

A loss of the nation’s Triple-A rating would have ripple effects beyond Treasury-backed municipal bonds, leading to downgrades across the board throughout the entire $2.9 trillion muni bond market. Interest rates will soar as creditors finally price in the real risk of default after decades of rampant deficit-spending by politicians at the state and local level.

Even fiscally responsible states like Virginia and Texas would likely face higher borrowing costs.

Ironically, it appears Democrat senators who oppose “Cut, Cap, and Balance” — the only proposal on the table that might avert such a credit action by agencies — are actually further endangering the fiscal outlooks of the blue states they represent, as a downgrade would hurt their homes the most.

States like New York, California, and Illinois already face intractable budget situations. Higher borrowing costs today associated with a downgrade will actually mean even bigger budget cuts down the road. For every point of interest borrowing increases, state and local governments across the country will owe another $29 billion a year. It is very much in those states’ interests that Washington gets its act together sooner rather than later.

Yet, these blue states’ own senators stand in the way. Supporters of the weak McConnell-Reid plan — which Moody’s says would not avert a downgrade as currently configured — believe the $111 billion in immediate cuts and 22 percent spending cap contemplated under “Cut, Cap, and Balance” are cruel and unwarranted.

But if they vote to reject “Cut, Cap, and Balance,” resulting in a downgrade, members risk guaranteeing a future of more austerity, more pain, and more uncertainty for their own constituents.

In other words, by fighting budget cuts in Washington, senators could be virtually guaranteeing more budget cuts home.

If Congress waits, the medicine necessary to cure the crisis will only become worse — when markets force a solution on us and the fountain of borrowed money runs dry. As bad as things are in Europe right now, a sovereign debt crisis in the United States would dwarf the pain being felt financially.

It will tear our society apart. For, the effects of a credit downgrade will be even more far-reaching than just state and municipal debt markets. It will affect real interest rates, lead to inflation, and even higher unemployment. It risks everything from pension funds to mortgage-backed securities.

But it’s even worse than that. A downgrade will most likely crash markets all over the world, erasing trillions of dollars of wealth in the blink of an eye. And it will be on the head of every senator who voted against “Cut, Cap, and Balance” — not to mention Barack Obama, who has sworn to veto it. An economic slump caused by this Administrations spend-a-thon will likely be fresh on voters’ minds in November 2012.

Do senators really want to say they didn’t do everything they could to avert a downgrade—and the great crash that follows?

Like the McConnell-Reid plan, the ‘Gang of Six’ plan will probably not avoid a downgrade either, because it defers much of its work to congressional committees, putting off the date any cuts would even be voted on. Action is needed now to cut spending.

This view was bolstered by BNP Paribas’ Bricklin Dwyer, who said, “A downgrade by S&P looks increasingly imminent regardless as the Gang’s plan is simply not credible and even on the best hope would fall short of the stated USD 4.0 [trillion] of credible deficit reduction needed to avoid a downgrade.”

That means the Senate has but one credible option in front of it, it is the bipartisan “Cut, Cap, and Balance” plan that will cut borrowing by $5.8 trillion over ten years and send a Balanced Budget Amendment to the states. Any plan that contemplates less savings, defers the hard work to back-room ‘commissions’ and stacked committees, and fails to balance the budget should not even merit consideration.

In order to reassure credit markets, and to spare the nation the scourge of a downgrade, Congress needs to make the big cuts now and put the nation on the path to a balanced budget — before Washington hopelessly turns into Athens.

Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.

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