Standard & Poors (S&P), one of three international credit-rating companies, issued a Research Update on Friday evening, August 5, 2011, in which it downgraded the credit rating of the United States of America, for the first time in history, from an AAA to an AA+ rating.
The actual S&P Research Update of August 5, 2011, downgrading the U.S. credit rating, was published by S&P on their website. It is entitled, “United States of America Long-Term Rating Lowered To ‘AA+’ On Political Risks And Rising Debt Burden; Outlook Negative.”
In stating its Rationale for the downgrade, S&P wrote:
S&P goes on to state that, “in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently.” They point to the facts that the recent law included only “relatively modest savings on discretionary spending,” failed to address entitlement reform in a serious way, and “It appears that for now, new revenues have dropped down on the menu of policy options,” as reasons for the downgrade.
Reaction to the downgrade has included a flurry of political spin, with Republicans trying to blame the President, and some commentators criticizing S&P for their action as well as for the agency’s past screw-ups in rating as AAA toxic collateralized debt obligations created by Wall Street that caused the implosion of our economy in 2008.
But, few so far have examined the actual text of S&P’s Research Update itself, and tried to understand what exactly S&P is saying and what it means. Nor have many noticed that this downgrade is all about the failure of policy makers in Congress to address the looming fiscal crisis that an aging population and consequent mushrooming of health care costs threatens for our economy — a threat that S&P previously warned of in a June 21, 2011 report it cites in its rationale for the current downgrade.
What is S&P Actually Saying?
Since these issues directly impact the future ability of all of us — especially the Baby Boom Generation — to finance and procure needed health care coverage and services in our rapidly approaching senior years, it behooves us to look carefully at what S&P is actually saying.
Rising Health Care Costs for An Aging Population = Primary Cause of Crisis, S&P Says
In all the political finger pointing and hot rhetoric, few have noticed that in its Rationale for its current rating action, S&P specifically cites its previous report, “Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now,” issued on June 21, 2011. In that report, S&P warned that a “looming U.S. fiscal bill is growing as the population gets older,” and that “the challenges facing the U.S. are more severe than those facing many of the other major industrial societies … because of its rapidly escalating health care costs.”
S&P’s June, 2011 report introduced the subject by stating:
In that June report, S&P pointed out, “In 2010, there were 26 retirees for every 100 members of the U.S. labor force. By 2050, however, we expect that there will be 50 retirees per 100 workers. In other words, the U.S. will go from four workers to support every retiree to only two.”
These ratios are better in the U.S. than in some other countries (such as Japan and Italy which “will have only one worker per retiree by 2050″), S&P said, “thanks to a somewhat higher birth rate and a much higher immigration rate” in the U.S.
Nevertheless, S&P projected in June, 2011, that if no changes are made in U.S. policy (including tax policy and spending for entitlement programs), government debt would reach 600% of GDP by 2050! With no change in policy, S&P said in June that this level of mushrooming debt would cause further downgrades in the U.S. credit rating to “A” by 2020, to “BBB” by 2025, and to “Speculative grade” by 2030 and thereafter. This would likely cause investors to move away from U.S. government bonds and notes, costing the U.S. government and consumers skyrocketing interest rates and further impairing our ability to pay our debts or provide the services required by our aging population.
S&P stated in June that this scenario was a hypothetical, and S&P did not project this would actually happen, because it then assumed that policy makers in Washington would act to address this looming crisis.
S&P stated, however, that the impetus for issuing its warning report in June, 2011 was the extension of the Bush tax cuts which Congress implemented in December, 2010. S&P stated that continuing these tax cuts, had caused S&P to raise their projections of government debt from 400% of GDP to 600% of GDP by 2050, absent any other policy changes. This worsening of their projections, S&P said, “is primarily due to the effect on the general government budgetary trajectory of the December tax agreement.”
In its June, 2011 report, S&P attributed the cause of our looming crisis principally to rising costs of health care and long-term care as our population ages, and to the failure of policy makers to come together to address the shortfall.
The Agency said:
“Health care inflation is higher in the U.S. than in most other countries, both in absolute terms and relative to other prices,” S&P said. They made clear that this and the aging population are the primary drivers of the projected increase in government spending on health care in the U.S. S&P did not advocate that the public sector should pay a smaller percentage of the total health care bill in the U.S. In fact, they noted that in the U.S. “public expenditures cover less than half of U.S. health care costs,” while in OECD countries the public sector pays 72% or more of health care costs. What they did advocate is that policy makers must come together to find a rational approach to pay for future required government spending on health care as our population ages.
Social Security is also not the principal problem, according to S&P. They projected that “Social Security payments will increase as the baby boomers enter retirement age over the next 20 years,” from the current 4.8% of GDP “to a peak of 6.2% of GDP in 2035 and then drop back to 5.9% in 2050.” The “modest size” of this issue, S&P said, suggests the government could solve it through some combination of raising the full retirement age for persons born after 1960, slightly increasing contribution rates, means testing and other measures.
Political Solution Required, S&P Warns
Toward solving the principal problem of escalating government health care costs, S&P noted that the Patient Protection and Affordable Care Act of 2010 will help in that it “contained provisions for cost containment,” which “could — depending on yet-to-be-determined specifics — lead to significant long-term cost savings.” But, S&P said, “some uncertainty exists about the ability of these provisions to control or cut costs significantly in the long term, especially given opposition to the [Patient Protection and Affordable Care Act] and a more closely split Congress since the Republicans picked up seats last November.” [emphasis supplied]
S&P noted that,
In it June, 2011 report, however, S&P concluded with a warning that failure of political leaders to come to agreement and take reasonable action to address the looming fiscal crisis driven by escalating health care costs for our aging population, would in fact lead to a downgrade of the U.S.’ credit rating. S&P set the stage for its present downgrade of the U.S. credit standing in concluding its June, 2011 report with this warning:
S&P’s Rationale for its Current Downgrade of the U.S. Credit Rating
With this background, the current S&P downgrade of the U.S. credit rating was quite predictable, given what S&P now termed, “the political brinksmanship of recent months,” which prevented policy makers in Washington from reaching agreement on a viable long-term or medium-term solution for the looming fiscal crisis of which S&P had warned in June.
As quoted in part above, in S&P’s words:
S&P’s references to “the political brinksmanship of recent months” in which “The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy,” are easy to understand, given recent statements made by Senate Minority Leader Mitch McConnell (R – Kentucky). Following adoption of the recent compromise hammered out by President Obama and Congressional Leaders after months of threats by Republicans in Congress to block raising of the debt ceiling if their particular fiscal proposals were not agreed to, Senator McConnell was quoted on August 2, 2011 in the Washington Post as saying:
Then on Larry Kudlow’s show on CNBC, Senator McConnell essentially threatened to continue holding the debt ceiling and the ability of the U.S. government to pay its bills “hostage” to the policy demands of his party, saying:
With these widely quoted statements by the Minority Leader of the U.S. Senate, it is easy to understand S&P’s reference to “political brinksmanship” in which “The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy.”
S&P said that, “Standard & Poor’s takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.’s finances on a sustainable footing.” Nevertheless, in describing the recent budget compromise bill, they stated that it “fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently,” and they pointedly mentioned that, “The act contains no measures to raise taxes or otherwise enhance revenues, though the committee could recommend them.”
In their credit downgrade report, S&P based their worsening projections of the U.S. budget deficit on revised and downgraded base case assumptions. “Compared with previous projections,” they stated, “our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place.” “We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act,” S&P said.
Based on this “base case scenario,” they projected that the “net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021.”
Further, based on these base case assumptions, including their assumption that the Bush Tax Cuts will not be allowed to expire, S&P warned that this economic scenario could lead to a further downgrade of the U.S. credit rating to “AA.” The S&P report referred to “Our revised downside scenario–which, other things being equal, we view as being consistent with a possible further downgrade to a ‘AA’ long-term rating.”
On the other hand, S&P said that a scenario that would enable the U.S. to retain the “AA+” rating and avoid further downgrade would include elimination of the Bush tax cuts “for high earners.” They said, “Our revised upside scenario–which, other things being equal, we view as consistent with the outlook on the ‘AA+’ long-term rating being revised to stable–retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating.”
Solutions for the Future
While specifically not taking a position on the exact mix of revenue increases and spending cuts required, S&P does seem to be advocating a balanced approach to deficit reduction, such as that recommended by the Simpson Bowles Commission — including both spending cuts and increased revenues — at least to the extent of allowing the Bush tax cuts to expire for “high earners.”
In fact, they concluded their report by saying that this is necessary just to maintain the now downgraded “AA+” credit standing, and avoid further downgrade:
The agency said that on Monday, it will “issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors.”
See the full text of the S&P August 5, 2011 Report Downgrading U.S. Credit Rating, entitled, “United States of America Long-Term Rating Lowered To ‘AA+’ On Political Risks And Rising Debt Burden; Outlook Negative.”
See the full text of S&P’s June 21, 2011 report, “Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now.”
See our previous HelpingYouCare™ report on:
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