WASHINGTON -- There has been a quick and concerted effort on the part of Democrats to paint House Speaker John Boehner's final debt ceiling proposal as insufficient to avoid the possibility of a downgrade of the United States' AAA rating.
When CNN's Erin Burnett reported Monday evening that the raters at Standard & Poor's would not be satisfied with a plan that neither lifted the debt ceiling through the 2012 elections nor reformed entitlement programs, party leadership jumped on the news.
If the sequence seemed a touch too political, it shouldn't have. Even before Boehner (R-Ohio) offered his plan, which would force $1.2 trillion in cuts over 10 years while creating a powerful congressional commission to find $1.8 trillion more, Wall Street was warning that a short-term increase in the debt ceiling would be insufficient.
A July 22, 2011 report by Bank of America Merrill Lynch, passed to The Huffington Post by a Wall Street source, outlined the economic fallout of a resolution to the debt ceiling crisis along the lines of what Boehner is crafting. Their forecast was far from reassuring. The report reads:
- Our base case view is that the debt ceiling will be lifted around August 2. The resolution will involve a short-term extension and a provision for a commission to draft out a longer-term fiscal plan. However, this creates the risk of no follow-through on the tough decisions in an election year and should keep fiscal risk alive in the markets.
- We expect a knee-jerk reaction of lower rates and a flatter curve on the announcement of such a plan. However, we would expect the reaction to be reversed due to credibility issues. We recommend a core steepening stance.
- We expect S&P to downgrade the US credit rating to AA at some point in the next couple of months. We expect the other rating agencies to keep the outlook to negative.
- The most significant risk to our base case scenario is that the debt ceiling is not raised and the Treasury defaults or needs to prioritize payments.
Like Burnett's reporting, the Bank of America document is not entirely definitive. For starters, the Boehner proposal had not yet become public when the report was issued on Friday. Secondly, their main gripe with a short term extension is not, necessarily, that it fails to resolve the debt ceiling issue through the 2012 elections, but that it fails to address structural reforms to the nation's entitlement programs -- something that the rating agencies have quickly come to prioritize as an outcome of the current debate.
In a brief phone interview, Priya Misra, BofA Merrill Lynch's Head of U.S. Rates Strategy Research and one of the authors of the report, clarified that there were two issues that were souring the bank's view of the Boehner plan. Most immediate was the fact that it did not resolve the debt ceiling issue through the 2012 elections. More broadly was the fact that it did not guarantee entitlement reforms.
"It's a combination of both," Misra said. "A short term deal means we will be back in this situation and we are not taking any of the tough decisions right now … the credit agencies want a $4 trillion plan committed to right now, or with a very high chance of implementation over the next ten years … The Boehner plan has a lot less teeth in terms of [debt reduction] because the committee it creates is just supposed to come up with cuts of $1.8 trillion, which is not that large."
The problem, as Misra notes, is that the Democratic alternative only satisfies one of those two concerns -- it gets the debt ceiling raised through 2012. But on entitlement reform, it falls back on the same committee proposal as Boehner outlines.
"It resolves the debt ceiling problem but does not resolve the long term problem," she said of Senate Majority Leader Harry Reid's plan.
The ideal solution, from the market's standpoint, would be to go with a grand bargain, like the one envisioned by the White House or the Gang of Six. But those options appear close to dead at the moment. And in that regard, the Bank of America report provides another data point to bolster Democrats' argument that the Boehner alternative is the more inadequate one -- not just on political grounds (it remains questionable as to whether it has the votes to pass Congress) but on economic grounds as well.
UPDATE: A Republican source notes that Standard & Poors has not actually taken a definitive position on any proposal in the debt ceiling debate but, rather, has stressed the need for the U.S. to pursue a broader debt reduction strategy. As such, the notion that a credit downgrade could result from Boehner's plan is speculative.
The rating's agency released a statement on Tuesday that said as much.
On July 14th, S&P placed the credit rating of the U.S. on CreditWatch Negative. In announcing the CreditWatch, S&P highlighted several factors that it will consider in determining whether to revise its 'AAA' rating on the U.S., including the need for lawmakers to agree on a plan to deal with the federal deficit and develop a credible solution to the country’s debt burden.
Standard & Poor’s has chosen not to comment on the many and varying proposals that have arisen in the current debate. Any statement to the contrary is inaccurate.