As the clock ticked toward default over the summer, President Obama took aim at Republican intransigence on taxes, warning that interest rates would soar if the United States lost its coveted AAA rating. It would, he said, amount to “a huge tax hike on the American people.”
He was wrong.
Rates on everything from home and car loans to credit cards are either unchanged or, in many cases, lower than they were when Standard & Poor’s stripped the United States of its top-notch rating three months ago.
The risk was always low, and many economists knew that even as the president made his dire prediction.
“They were never likely to soar,” said Nigel Gault, chief U.S. economist at IHS Global Insight.
The situation in Europe was deteriorating rapidly over the summer, increasing the relative safety of U.S. Treasuries despite political gridlock in Washington. Investors flock to the United States’ large, liquid bond market when other economies appear uncertain, and as long as markets view the United States as a safer place to invest, Treasury rates and other correlated borrowing costs should remain steady or even drop.
That’s precisely what happened. Standard & Poor’s downgraded the United States on Aug. 5. On that day, 10-year Treasury yields stood at 2.58 percent. On Tuesday, they were quoted at 2.03 percent.
Interest rates on credit cards, mortgages, and car loans also have remained steady or declined since August. Credit cards’ fixed-rate APR was largely unchanged as rates on the 30-year fixed mortgage dropped, hitting a record low of 3.94 percent in October. Despite Obama’s warning, 72-month new car loans fell from 3.75 percent in August to 3.30 percent in November.
Obama argued that if the United States lost its AAA rating, the rest of the world would “wonder whether the United States is still a good bet.” In that July 25 address to the nation, he said: “Interest rates would skyrocket on credit cards, on mortgages, and on car loans.”
That could have happened—if not for Europe.
“In theory, he was right,” said Paul Dales, senior U.S. economist at Capital Economics. “In a textbook economy, with nothing else going on, then yes, they would have spiked. But there’s lots of other things going on.”
The president has access to some of the country’s best economists, who would have been able to predict the impact of the European situation. They would have known that markets had already priced in a potential downgrade after ratings agencies said they were prepared to do so.
The president’s warning appears political, not economic.
“The president wanted a deal to get done," said Gault "One way to get a deal done is say, ‘OK, look, bad things might happen if we don’t do this.’ There’s also the unspoken prestige question. You don’t want the U.S. to be downgraded on your watch as president.”
In fact, there’s little risk that consumers will face the equivalent of a “huge tax hike” caused by interest rates any time soon.
Markets already have priced the possibility that the super committee, charged with finding at least $1.2 trillion in deficit reduction over 10 years, will fail to reach an agreement next week. They’ve also priced in another possible downgrade. As long as the situation in Europe remains more worrying than that of the United States, which it is likely to do for the foreseeable future, the United States will remain a better bet in investors’ eyes.
But Greg McBride, the senior financial analyst at Bankrate.com, cautions that the impact of the summer’s downgrade could be felt down the line.
“It’s like a poor diet. Sooner or later it catches up with you,” he said. “Right now, despite the downgrade, we haven’t put on weight because we’ve had other illnesses to contend with, specifically worries about the economy and Europe’s debt issues.”
Once those evaporate, investors will begin to more closely scrutinize the benefit of investing in U.S. Treasuries. Still, a resolution for Europe’s woes is a long-term proposition, with many of the problems structural ones that will take years to fix.
Kevin Jacques, a finance professor at Baldwin-Wallace College who served as an economist at the Treasury Department for 14 years, says interest rates could rise in a scenario that also is far on the horizon. If inflation jumps in 2012, the Fed could be driven to raise the federal funds rate sharply in mid-2013 when its pledge to keep it at rock-bottom levels runs out. That too seems unlikely. The Fed noted after its most recent monetary policy-setting meeting that inflation seems to have moderated since the beginning of 2011.
As far as President Obama goes, part of his job is warning about bad things that could happen to the economy, Gault said. If he didn’t do that this summer, he risked sending a message to markets that he didn’t care about reducing the deficit. “It’s not something he can afford to be complacent about,” he said. “It’s much easier for outsiders to be complacent about.”
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