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What A Credit Ratings Cut Could Mean For The U.S.

Traders work on the floor of the New York Stock Exchange in April. The country's credit rating could suffer if Congress fails to address the nation's long-term debt. (Getty Images)

With a debt ceiling deadline approaching, party leaders spent the day counting votes.

There are two plans: One, the handiwork of House Majority Leader John Boehner (R-OH), the other from Senate Majority Leader Harry Reid (D-NV).

The problem is that it's not clear that either can muster the votes necessary for approval.

On Monday night, President Obama dramatized the threat this way:

"For the first time in history, our country's triple-A credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet," he said. "Interest rates would skyrocket on credit cards, on mortgages and on car loans."

I would not be at all surprised if someone at Treasury was talking to rating agencies and saying, 'Well, what do you need? What do we need to avoid a downgrade? Minimum of what? How much deficit reduction?' I would be very surprised if they weren't talking to them about that.
Joseph Gagnon, economist at the Peterson Institute

But it's not clear how big of a problem a credit downgrade would be.

There's no debate that if the U.S. defaults on its debt, it will be a big deal. But whether it will be as catastrophic as the administration says depends on how markets react.

However, there's little doubt that a default would be very costly.

A Public Relations Issue

And what if it's just a downgrade? The government's borrowing costs would probably go up. But some experts say a downgrade is primarily a public relations issue.

"Not meaningless, because it's sort of a nice focus for the press, but it just isn't a big financial deal," says Joseph Gagnon, an economist at the Peterson Institute. He says what matters far more is how we arrive at that downgrade.

Let's say there's still a stalemate, and though there's no default, the government runs out of cash to pay its workers, contractors and Social Security benefits. That, Gagnon says, could trigger another recession.

But ratings agencies are also warning of a downgrade even if Congress raises the debt ceiling, if it doesn't also address long-term deficits. Gagnon says the economic impact of that kind of downgrade could easily be a non-event.

"You know, oftentimes, the rating agencies are behind the curve, and this is certainly the case now — where the rating agencies don't have any additional information that everyone else in the market has already," he says.

Japan's sovereign debt rating was cut in 2002, and he says there wasn't a big effect.

It turns out, this opinion is shared by Standard & Poor's itself. In a series of reports published last week, the ratings agency assessed the likely impact of a potential downgrade. It said, in short, that it wouldn't have much of an impact.

In fact, some say given the financial situation in the U.S. it probably should have happened a long time ago.

"I would have downgraded them 10 years ago," says Kent Smetters, a former Treasury official and now a professor at the Wharton School.

'The Guts To Compromise'

Smetters says that for many years he's believed that interest, Social Security and medical entitlement payments were going to rise unsustainably, leading us to this point. And what's really lost if U.S. credit gets downgraded is any credibility that politicians on both sides have the guts to compromise.

"For me, the downgrade reflects something bigger than that," he says. "It's a statement that basically says to the world, 'It's not even obvious that we're serious about dealing with the longer term problems.'"

But politicians like to suggest the country's credit rating has close ties to consumers' credit.

"I think that is a way of trying to get the voter base into action, but it's not going to have as dramatic of an impact on mortgages and credit card rates," Smetters says.

That's not to say a rating cut won't look bad.

"I would not be at all surprised if someone at Treasury was talking to the rating agencies and saying, 'Well, what do you need? What do we need to avoid a downgrade? Minimum of what? How much deficit reduction?' " says the Peterson Institute's Gagnon. "I would be very surprised if they weren't talking to them and trying to get that."

Because if you can avoid both economic and public relations fallout, why wouldn't you?

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Transcript

ROBERT SIEGEL, Host:

From NPR News, this is ALL THINGS CONSIDERED. I'm Robert Siegel.

MICHELE NORRIS, Host:

And I'm Michele Norris. The debt ceiling deadline is now just a week away, and party leaders in Washington spent the day counting votes. Each side has its own plan, but it's not clear that either has the votes necessary for approval. Last night, President Obama laid out some of the stakes of this impasse.

P: For the first time in history, our country's triple-A credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet. Interest rates would skyrocket on credit cards, on mortgages and on car loans.

NORRIS: But as NPR's Yuki Noguchi reports, it's not clear that all of that would happen, and some say the real effects are hard to predict.

YUKI NOGUCHI: First, let's make a distinction. If the U.S. defaults on its debt, it will mean big problems. Whether it will be catastrophic, as the administration says, depends on how markets react. And there's little doubt it would be very costly. But what if there's no default, and it's just a downgrade? The government's borrowing costs would almost certainly go up, but some experts say a downgrade is primarily a public relations issue.

JOSEPH GAGNON: Not meaningless, because it's sort of a nice focus for the press, but it just isn't a big financial deal.

NOGUCHI: That's the opinion of Joseph Gagnon. Gagnon is an economist at the Peterson Institute, and he says what matters far more is how we arrive at that downgrade. Let's say the stalemate continues, and the government runs out of cash to pay its workers, contractors and Social Security benefits. Well, that might not be a default, Gagnon say. It might push the economy into another recession - a big deal. Gagnon says there's another scenario, less scary and more likely.

Ratings agencies may downgrade the U.S.'s credit even if Congress does raise the debt ceiling, if it doesn't address long-term deficits at the same time. The economic impact of that kind of downgrade, Gagnon says, could easily be a non-event.

GAGNON: You know, oftentimes, the rating agencies are behind the curve. And this is certainly the case now, where the rating agencies don't have any additional information that everyone else in the market has already.

NOGUCHI: Japan's sovereign debt rating was cut in 2002 and...

GAGNON: There just wasn't a big effect.

NOGUCHI: It turns out, this opinion is shared by Standard Poor's itself. In a series of reports published last week, the ratings agency assessed the likely impact of a downgrade not accompanied by default. It said, in short, not much. In fact, some say, given the financial situation in the U.S., it probably should have happened a long time ago.

KENT SMETTERS: I would have downgraded them 10 years ago.

NOGUCHI: Kent Smetters is a former Treasury official, and now a professor at the Wharton School. Smetters says for many years, he's believed that interest payments, Social Security and Medicare were going to rise unsustainably - as they have. He says what's being revealed with the threat of a downgrade is that politicians on both sides have lost the ability to compromise.

SMETTERS: It's a statement that basically says to the world, it's not even obvious that we're serious about dealing with the longer-term problems.

NOGUCHI: Smetters says politicians like to suggest the country's credit rating has close ties to consumer credit, but he's skeptical.

SMETTERS: I think that is a way of trying to get the voter base into action, but it's not going to have as dramatic of an impact on mortgages and credit card rates.

NOGUCHI: That's not to say a rating cut won't look bad. Here, again, is the Peterson Institute's Joseph Gagnon.

GAGNON: I would not be at all surprised if someone at Treasury was talking to the rating agencies and saying, well, what do you need - what do we need to avoid a downgrade? Minimum of what? How much deficit reduction? I would be very surprised if they weren't talking to them and trying to get that.

NOGUCHI: Because if you can avoid both economic and public relations fallout, why wouldn't you? Yuki Noguchi, NPR News, Washington. Transcript provided by NPR, Copyright NPR.

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