By Yali N’Diaye

WASHINGTON (MNI) – U.S. rating agencies, regardless of their rating
actions or inaction on the U.S. sovereign debt so far, have made it clear that
2013 could be the year of downgrade in the absence of a “credible” long-term
deficit reduction plan.

In the short-term, avoiding the fiscal cliff will be key, and rating
agencies do expect that will be the case, at least in large part.

The political process by itself will also be watched, including how
Congress addresses the next debt ceiling deadline in the first quarter of 2013.
On that front, avoiding a repeat of the 2011 political fiasco will be important.
That is: the government must avoid a last-minute agreement.

Those two events are not even the key challenge, although they will likely
impact the assessment of the ability and willingness of the U.S. government to
reach a longer-term fiscal agreement. The challenge has not changed since
Standard & Poor’s downgraded the U.S. in 2011 — the U.S. must bring back the
fiscal and thus debt trajectory onto a sustainable path. That means finding a
long-term deficit reduction plan which would likely have to tackle entitlements.

The plan implementation can be gradual over time, but what seems to matter
more is the size of the reduction, which should be big enough to convince rating
agencies that the country’s debt trajectory will be rectified as a result.

Standard & Poor’s and Egan-Jones have already downgraded the country’s
sovereign rating to AA+ and AA-, respectively.

The question is whether Moody’s and Fitch, which both have a negative
outlook, will follow suit.

While Standard & Poor’s downgrade in August 2011 has hardly penalized the
U.S. in terms of interest paid on the debt, downgrades by two more agencies, and
potentially an additional one by Standard & Poor’s, would undoubtedly impact the
cost of financing the U.S. debt.

“Failure to avoid the fiscal cliff and raise the debt ceiling in a timely
manner as well as securing agreement on credible deficit reduction would likely
result in a rating downgrade in 2013,” Fitch said the day after the election.

“Our assessment of the creditworthiness of the government, and hence the
direction of the sovereign rating and its outlook, depends on the outcome of
budget negotiations during 2013 and the ability of policymakers to reach a
consensus that produces a stabilization and then a downward trend in the ratio
of federal debt to GDP over the medium term,” Moody’s said the same day.

However, it remains unclear whether Moody’s and Fitch will follow through
their warnings, and how tolerant they will be in their assessment of “credible.”

Bank of America Merrill Lynch does “expect some rating agency actions in
2013.” The bank’s analysts pointed out that in a recent U.S. Macro Viewpoint
that in the absence of a medium-term plan, Moody’s has already warned it would
downgrade the U.S. to Aa1.

They also noted that “to prevent an eventual downgrade, S&P would need to
see a reversal in both of these trends,” referring to the worsening in trends on
the political and fiscal fronts.

Marc Joffe, Principal Consultant at Public Sector Credit Solutions, told
MNI that a downgrade of the U.S. sovereign debt is “unlikely,” but not
necessarily because it is not warranted.

In fact, he stressed that any entitlement reform would probably fall short
of what is needed.

“The baby boom generation is already in the process of retiring,” he
pointed out. “If Social Security adjustments are phased in gradually like they
were under the 1983 plan, most boomers will be unaffected by the reform,” he
continued, adding that the same goes with Medicare. “If people over 50 or 55 are
exempt from the reforms, most boomers will receive full benefits,” he said. “The
2020s and 2030s will thus be an era of very large deficits and a potential
sovereign debt crisis in the U.S.”

But the reason Joffe does not see Moody’s or Fitch follow through is more
of a political one.

“After seeing the kind of criticism that S&P took, I would be surprised to
see either Moody’s and Fitch follow,” he commented. So in his view, “As long as
there is some kind of deal, they will have an excuse to avoid downgrading.”

Some experts following rating agencies have raised questions in private
about the timing of the resignation of former Standard & Poor’s president Deven
Sharma. The move was announced only a few weeks after the firm downgraded the
U.S. sovereign rating to AA+ on August 5, 2011.

The other only other registered rating agency to have downgraded the U.S.
is Egan-Jones, which is the subject of an enforcement action by its regulator,
the Securities and Exchange Commission.

Here too, the skepticals argue the timing the SEC’s action is suspicious,
as it came in the same month, April 2012, Egan-Jones downgraded the U.S. to AA
from AA+.

In addition, they point out that the enforcement action was not brought
because of wrongdoing related to the ratings but because of irregularities
surrounding the registration process, and which should have been caught at the
time of the registration instead.

The SEC cited “willful and material misrepresentations and omissions in its
July 2008 application to the Commission to register as an NRSRO for issuers of
ABS and government securities.”

In its summary of rating agencies examinations released Thursday, the SEC
staff said “The Commission’s administrative proceeding is pending, with a
hearing currently scheduled for later in 2012.”

It added, “In June 2012, EJR and Mr. Egan filed a complaint in Federal
District Court seeking to have the Commission’s administrative proceeding
removed to Federal Court,” adding, “The Federal District Court case is also
pending.”

Another player on the government rating field could weigh in the overall
balance. HR Ratings de Mexico was granted registration on November 5, and has
yet to produce its first sovereign rating on the United States.

U.S.
Long-Term Credit Watch
rating Outlook

DBRS* AAA Stable

Moody’s* Aaa Negative

Fitch Ratings* AAA Negative

Standard & Poor’s* AA+ Negative

Egan-Jones* AA- N/A (rating watch developing)

Source: Rating agencies.

* Nationally Recognized Statistical Rating Organizations registered
with the Securities and exchange Commission.

** MNI Washington Bureau: 202-371-2121 **

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–email: yndiaye@mni-news.com