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US Debt: why the deadlock may not turn to disaster

An eerie calm has descended over markets as the world waits to see if President Obama and his Republican opponents can settle their differences over US borrowing and avoid a credit downgrade.

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by Max Julius on Jul 26, 2011 at 17:04

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US Debt: why the deadlock may not turn to disaster

Deadlocked talks over plans to cut spending and raise the US debt ceiling have stoked fears that the United States will suffer a credit rating downgrade, and may even default – yet markets are eerily calm.

Ratings agency Standard & Poor’s last week said a federal default could trigger ‘a systemic and global macroeconomic disruption’ similar to that of 2008. And on Monday, the International Monetary Fund urged the US to lift its debt ceiling swiftly for the sake of the US and global economy.

‘We would risk sparking a deep economic crisis – this one caused almost entirely by Washington,’ warned Barack Obama, US president, in a nationally televised address. ‘Defaulting on our obligations is a reckless and irresponsible outcome to this debate.’

S&P’s ‘selective default’

Julian Jessop, chief international economist at Capital Economics, pointed out that while the US was unlikely to default on its debt, should it do so, the implications would potentially be far more serious than those of a downgrade.

‘The damage to sentiment in global financial markets caused by the prospect of default by the Greek government would presumably be multiplied many times over if it were the US that could not service its debts,’ he warned.

But he said that even in the event of what S&P brands a ‘selective default’ on a specific issue, meltdown should be avoidable as the ratings agency believed the US would continue to meet its payment obligations on other ‘classes of obligations.’

‘We would expect the key players to make the most of the wiggle room that this would allow,’ he said.

Nonetheless, Mike Lenhoff, chief strategist at Brewin Dolphin, sees even this situation as highly unlikely.

‘At the end of the day, an investor has to ask themselves: “What is the risk of my not getting the coupon and my money back”’ he said. ‘And I think from the United States, that risk is very low – no matter what the credit rating agencies do or say.”’

No Lehman-like catastrophe

Other analysts agree that a default is unlikely, but as Bob Doll, chief equity strategist at BlackRock, notes: ‘The wild card in all of this is the ratings agencies.’ Indeed, S&P noted that raising the debt ceiling was necessary but not sufficient to avoid a downgrade.

‘A potential downgrade of US treasuries from AAA to AA has emerged as the greatest threat to the markets over the last several weeks,’ Doll said. ‘Any downgrade of US debt would have serious negative implications since investors who are required to hold AAA debt would be forced to divest from treasuries.’

Lenhoff said that bond and equity markets would be likely to ‘respond’ to a one-notch downgrade.

‘Whether we’re going to see a major sell-off – I’m not so sure,’ he continued. ‘A bond trader is very unlikely to get up in the morning and say, “Christ Almighty – I can’t buy US treasuries anymore.”’

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13 comments so far. Why not have your say?

Normally the correct attitude to these shenanigans, which have occurred over the years with some regularity, has been to keep calm and carry on, assuming that there will be some compromise or fudge at the 59th minute of the 24th hour. On this occasion, I am a bit more nervous about the arrival in the House of a large element of tea partiers, making political differences even less reconcilable than normally. While a failure might not be the next Lehman event, markets do seem to be showing a posssibly excessive sangfroid at the prospect.

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A lot of people are worried about Tea Partiers, but keep in mind, when this country has a crisis, the millions of diverse people spread over thousands upon thousand of square miles come together as one. "We walk real proud and talk real loud" as said in a song popular a couple of decades ago. We WILL make it. God Bless the USA!

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We WILL be okay. We will "walk real proud and talk real loud" again. We are a very diverse population - millions of people spread over thousands of square miles, but in a real crisis we become one. Washington - a bunch of them will be out of work next year. God Bless the USA.

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"God Bless the USA"?????

Strewth! Where DO these people get off?!

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It does not matter a jot what the rating agencies think they are discredited and have been shown to be corrupt. Let them take on the US it may just provide the trigger to see them brought to justice for their significant role in event of a couple of years ago. Of course the US will pay its bills and over time the deficit will be cut. Obama is looking to secure another term and is not afraid to use the public purse to secure this objective just as he did not shy from mugging BP over the GOM spill. It is a good excuse for the financial media to keep hyping te markets. Once this passes they will find something else.

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Although the USA is the largest economy in the world,it is a dysfunctional mess that ranks low in terms of per capita income.

The USA caused the 2008 financial crisis,and is set to cause the 2011 financial crisis.

Raising the debt ceiling may prove a temporary respite,but every alcoholic swears that the only cure for a hangover,is the hair of the dog that bit him. The USA suffers from hubris on a grand scale.The future of the USA is not promising.

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the usa have a tremendous capacity to rebound and will...later

it is time for americans to realize that Obama has inherited a huge mess made by Bush and friends and that the republicans show now how they do not care about the people, only about keeping all advantages to the richest.

Obama has a tough time but overall he deserves to be reelected!!

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If you have ever needed to transact with a bank in the USA you'd know they are not the smartest bunnies on the block!....and didn't those rating agencies give a rather high rating to those worthless US mortgages that started the crash?

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Rob yes those rating agencies have NOT done their job then...and now they play nasty games.

It is crucial for europe to get its own rating agency to counterbalance their "power"

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Credit decisions have been moving in-house at investment banks for a long time. The ratings agencies have been losing grip since Lehmans.

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I can understand how a ratings agency can assess the likelihood of a company - even a very large multinational company - being able to pay its bondholders, but when you get to half a continent like the USA . . . . . ??

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simone lienhart

The Fitch Group is a majority-owned subsidiary of Fimalac, S.A., headquartered in Paris, France. - Is Fitch not European ?

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simone lienhart

Jul 27, 2011 at 23:05

No ,according to my bank in europe..

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