–Any Abrupt Tsy Effort to Conserve Cash Could Create Long-Term Damage

By Denny Gulino

WASHINGTON (MNI) – Standard & Poor’s late Thursday placed the
United States on negative credit watch, saying there is a “one-in-two”
chance it will cut the AAA/A-1+ sovereign rating within 90 days.

The U.S. Treasury, forewarned, reacted immediately, as it did a day
earlier after a similar announcement from Moody’s.

“Today’s action by S&P restates what the Obama administration has
said for some time: that Congress mukst act expeditiously to avoid
defaulting on the country’s obligations and to enact a credible deficit
reduction plan that commands bipartisan support,” the early evening
statement said.

The White House earlier announced President Obama will hold his
second news conference this week Thursday morning on the subject of the
debt talks as they continue with congressional leaders. Treasury’s
borrowing limit must be raised by midnight Aug. 2 to avoid default of
its obligations, from the refinancing of Treasuries to a vast array
of government payments, including Social Security benefits.

Judging by their public statements, negotiators seem torn between
expediency — a short-term lifting of the borrowing ceiling without
substantial deficit reduction — and a much larger package extending
over several years that would shrink the accumulated deficits over that
time by trillions of dollars.

Wednesday Moody’s placed its U.S. Aaa government bond rating and
related ratings, like those of Fannie Mae and Freddie Mac, on review for
possible downgrade.

Moody’s cited the “rising possibility that the statutory debt limit
will not be raised on a timely basis, leading to a default on U.S.
Treasury debt obligations, possible as soon as mid July.

S&P Thursday cited two “separate but related” issues, both the
“continuing failure to raise the U.S. government debt ceiling” and “our
current view of the likelihood that Congress and the administration will
agree upon a credible, medium-term fiscal consolidation plan in the
foreseeable future.”

S&P said it still anticipates the debt ceiling will be raised soon
enough to avoid default. “However, if the government is forced to
undergo a sudden, unplanned fiscal contraction — as a result of
Treasury efforts to conserve cash and avoid default absent an agreement
… we think that the effect on consumer sentiment, market confidence
and, thus, economic growth will likely be detrimental and long lasting.”

However, S&P went on to say that if the government actually does
miss a scheduled debt payment, “We believe the effect would be even more
significant and, under our criteria, would result in Standard & Poor’s
lowering the long-term and short-term ratings on the U.S. to ‘SD’ until
the payment default was cured.”

“Under our baseline macroeconomic scenario, net general government
debt would reach 84% of GDP by 2013,” assuming near 3% annual inflation
adjusted growth and a phasing out of the December extension of the Bush
tax cuts. “Such a percentage indicates a relatively weak government debt
trajectory compared with those of the U.S.’ closest ‘AAA’ rated peers
(France, Germany, the U.K., and Canada),” S&P said.

Earlier in the day, Federal Reserve Chairman Ben Bernanke was
questioned relentlessly by members of the Senate Banking Committee on
the effects of any default, saying the Fed could not offset the likely
“calamitous” effects by buying defaulted Treasurys.

“Treasury securities are critical to the entire financial system,”
he said. “They are used in many different ways, for example for
collateral” and “default on those securities would throw the financial
system potentially into chaos.”

He said that “certainly” default “would destroy the trust and
confidence that global investors have in U.S. Treasury securities in
being the safest and most liquid assets in the world.”

That trust and confidence, he said, “is a tremendous asset to the
United States, the quality and reputation of our Treasury securities,
and we benefit from it with low interest rates.” A default, he said,
would be a “self inflicted wound.”

Thursday’s debt talks between Obama, Treasury Secretary Tim
Geithner and congressional leaders of both parties were described as
friendlier than those Wednesday. They will continue through the weekend.

“Further delays in raising the debt ceiling could lead us to
conclude that a default is more possible than we previously thought,”
S&P said in its announcement the U.S. was being placed on a negative
credit watch. “If so, we could lower the long-term rating on the U.S.
government this month and leave both the long-term and short-term
ratings on CreditWatch with negative implications pending developments.”

“If Congress and the Administration agree to raise the debt ceiling
(with commensurate fiscal adjustments), we aim to review the details of
such agreement within the next 90 days to determine whether, in our
view, it is sufficient to stabilize the U.S.’ medium-term debt dynamics.
If we conclude that the agreement would likely achieve this end, all
other things unchanged, we would expect to affirm both the long- and
short-term ratings and assign a stable outlook,” S&P said.

However “If a debt ceiling agreement does not include a plan that
seems likely to us to credibly stabilize the U.S.’ medium-term debt
dynamics but the result of the debt ceiling negotiations leads us to
believe that such a plan could be negotiated within a few months, all
other things unchanged, we expect to affirm both the long- and
short-term ratings and assign a negative outlook, pending review of the
eventual plan,” S&P said.

A weak agreement, though, would lead to the loss of the U.S. AAA
rating accompanied by a continuing negative outlook.

S&P said it will issue separate announcements on government related
entities, financial institutions, insurance companies, public finance
and structured finace sectors in the United States.

In making the announcement about the U.S. sovereign rating, S&P
also delivered a vote of confidence for the Federal Reserve, affirming
the AAA rating of the New York Fed. “The stable outlook reflects our
view that the Federal Reserve’s basic structure and role as the central
bank have remained essentially unchanged since its inception,” S&P said,
and we expect them to remain so for the foreseeable future.”

** Market News International Washington Bureau: 202-371-2121 **

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