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How Washington's Disarray Could Prompt Another Credit Downgrade How Washington's Disarray Could Prompt Another Credit Downgrade

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How Washington's Disarray Could Prompt Another Credit Downgrade

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During the 2011 debt-ceiling fight, Standard and Poor's issued a historic downgrade to the U.S. credit rating.

Raising the nation’s borrowing limit, and thus avoiding a historic default, isn’t enough to prevent a potential downgrade. Not by a long shot.

Like a child who kicks and screams and whines before agreeing to do a chore, Congress can’t evade punishment by taking necessary action at the last possible second, experts said. Lawmakers have to prove they they’re mature enough to act on their own—to address America’s ballooning debt or risk the wrath of a downgrade to the nation’s top-notch credit rating.

“It’s like loan officers in banks,” said Bo Becker, a finance professor at Harvard Business School. “They’re supposed to look at your character to judge when they make a business loan and [credit-rating agencies are] doing the same for the U.S. government. It’s an important part of deciding how creditworthy someone is, what’s their moral fiber.”

The federal government is expected to breach its debt ceiling as early as mid-February, according to Treasury Department and private estimates. If lawmakers fail to raise it, the government may be unable to pay its lenders, thus resulting in a historic and rare default on the nation’s debt. Such an event “would have severe economic consequences,” Goldman Sachs economists wrote in a recent research note. Therefore, many expect Congress to raise the ceiling.

But even if lawmakers do raise the nation’s borrowing limit, it might not be enough to prevent another historic downgrade of the nation’s credit rating. (The first came from Standard & Poor's during the 2011 debt-ceiling fight, when the U.S. was downgraded from AAA to AA+.) And earlier this week, Fitch, one of the three main credit-rating agencies, put lawmakers on notice: A downgrade hinges not just on addressing the debt ceiling, but on Congress’s ability to tackle the government’s growing deficits.

“In the absence of an agreed and credible medium-term deficit reduction plan ... the current Negative Outlook on the 'AAA' rating is likely to be resolved with a downgrade later this year even if another debt-ceiling crisis is averted,” the agency wrote in a news release.

Raise the debt limit, they said, but don’t stop there.

The question on which corporate and government credit ratings are evaluated is a simple one: Is the borrower able and willing to pay the money it owes?

“Are they capable of paying back the IOU on time, that’s exactly it,” said Lee Ohanian, a UCLA economics professor and adviser to the Federal Reserve Bank of Minneapolis.

When it comes to the United States—and most governments, for that matter—the answer to the first part of the question is, yes, governments have the means to pay off their loans.

“Nation-states like the U.S., they have such immense ability to repay things through their taxing rights, but then it becomes more of a question of their willingness to honor debt,” Becker said. As lawmakers push off dealing with ever-expanding deficits, the money the nation owes continues to swell. And as that debt grows, so too does the size of the tax hikes and spending cuts needed to pay it down, making the decisions lawmakers face increasingly difficult.

Since they last clashed over raising the debt limit in 2011, lawmakers have tried to tackle the nation’s long-term debt problem. They famously set up a “super committee” whose recommendations would have required a lower-than-normal threshold to be passed into law, but none were issued. Congress also designed a package of spending cuts—also known as sequestration—so egregious that it would have forced them to tackle spending in a more thoughtful way. Ultimately, they just postponed the onset of those cuts until March 1.

The political climate is far from the only factor that goes into credit-rating decisions, but right now it’s the one that matters.

“The economy’s doing OK, it’s not fantastic, but it’s doing OK.… It really is mostly just down to the politics, to be honest,” said Paul Ashworth, chief U.S. economist at Capital Economics.

Though a credit downgrade could reinforce pessimism about the budget, the United States could weather it, the experts said. Crises abroad mean that the U.S. will likely continue to be viewed by investors as the safest place to park their money. And it’s not as though serious global investors are unaware of the state of affairs in Washington. The S&P downgrade during the last debt-ceiling fight didn’t have much of an effect.

“Typically when countries are downgraded their interest rates go up on the basis of that,” Ohanian said. “That hasn’t happened in the U.S. and the reason is because the world still likes the U.S. better than the alternative. And that’s been a sort of saving grace for us.”

But while a downgrade might not deal the devastating blow hitting the debt ceiling would, it would still be a sign that the nation is heading farther and farther down a very dangerous path. Dropping from an AA+ to an AA might not seem so bad, but it would be one more signal of Washington’s disarray.

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