Taking Credit

Given the events of the past several years—and, most certainly, the past few weeks—one should not be surprised that Fitch has threatened to downgrade the nation’s credit rating (as you may recall, S&P issued a similar warning in 2011, and followed through). Although Fitch believes that Congress will raise the debt limit, it observes that “the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default.”  Fitch seems positive on the US economy: “the U.S. economy (and hence tax base) remains more dynamic and resilient to shocks than its high-grade rating peers.” The key problems are political and institutional:

“The prolonged negotiations over raising the debt ceiling (following the episode in August 2011) risks undermining confidence in the role of the U.S. dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the U.S. This ‘faith’ is a key reason why the U.S. ‘AAA’ rating can tolerate a substantially higher level of public debt than other ‘AAA’ sovereigns.”

While Fitch applauds the stabilization of gross debt following the Budget Control Act of 2011 (i.e., the sequestration), it warns:

“public debt stabilisation at such elevated levels still render the US economy and public finances vulnerable to adverse shocks and in the absence of additional spending reform and revenue measures, deficits and debt will begin to rise again at the end of the decade. The U.S. is the most heavily indebted ‘AAA’ rated sovereign, with a gross debt ratio equivalent to double that of the ‘AAA’ median.”

As many Pileus readers will correctly remember, the credit rating agencies played an important role in the lead up to the financial crisis by issuing higher than warranted ratings (arguably a product of the incentives created by the “issuer-pays” compensation model) and often failing to verify the quality of the data they were plugging into their models. But the overall assessment of the US system issued by Fitch and earlier by S&P) seems spot on.

Ezra Klein and Evan Soltas have a fine piece on the situation. As they note: “What you see with the Fitch and S&P calls is that the market price on the U.S. political system doesn’t reflect what market participants are coming to believe about it: that a once capable and reliable system is now dysfunctional and unpredictable.”

Given the challenges facing the nation in the next several decades (massive unfunded liabilities, demographic changes that will increase the pressure on entitlements while reducing the tax base) one can only expect that the dysfunctions will only multiply.

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