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Wednesday, July 27, 2011

Credit hit worries Obama, Congress more than default

US debt crisis has escalated after Republicans were forced to rewrite their proposal to lift the debt ceiling, because they miscalculated how much the original plan would cut spending.

In an embarrassing development for John Boehner, the Republican Congress speaker, the Congressional Budget Office (CBO) ruled on Tuesday night that his bill would have only cut spending by $850bn over the next decade, not the $1.2tr he had aimed for. Republicans are now racing to rewrite the legislation, and have pushed back a Congressional vote on the plan from Wednesday to Thursday at the earliest.

Although Boehner was already struggling to find support for his package, the delay increases the risk that Washington will fail to agree a deal to raise the debt ceiling before 2 August, when the federal government is expected to run out of money.

The dollar dropped against other currencies on Wednesday morning as investors faced the possibility that America could default. Several economists believe the country will lose its AAA credit rating within months, which would push up its borrowing costs, even if the $14.3tr debt ceiling is increased in time.

The White House said on Tuesday it was working with Congress to devise a "Plan B" that might attract enough support. The two sides have been deeply divided for weeks, with Republicans demanding deep spending cuts and Democrats anxious to include tax rises as a major part of the deal.

Threat of a downgrade “is very damaging to all of us, and that would be a product of the dysfunction of Congress” said Rep. Peter Welch (D-Vt.), who led a faction of House Democrats who argued for a “clean” debt-limit increase early in the process, only to watch escalating chatter about the “Armageddon” of a missed deal feed scrutiny of the nation’s fiscal health.

S&P raised the threat of a downgrade July 14 by declaring that raising the debt limit alone might not be enough. It wanted to see an enforceable agreement to cut $4 trillion over 10 years to affirm the triple-A rating.

Administration officials were shocked by the move. They suggested privately that it did not seem to square with prior S&P reports, which said the nation’s larger budget problems could be dealt with over several years. Some administration officials dismissed the S&P report as little more than amateur political prognostication by people with limited understanding of how Washington works.

But the White House’s statements in the past week show a downgrade is now top of mind. Obama himself invoked the country’s triple-A rating in a rare prime-time address Monday as he outlined the consequences of default.

“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,” Obama said. “Interest rates would skyrocket on credit cards, on mortgages and on car loans, which amounts to a huge tax hike on the American people. We would risk sparking a deep economic crisis — this one caused almost entirely by Washington.”

Nearly every debt-limit conversation on Capitol Hill is infused with debate over the potential for either a downgrade, a default, or both. Democrats have embraced the argument of the White House: A short-term plan could result in a debilitating downgrade even if default is avoided.

Republicans are moving forward with their two-phase plan, but they’ve shown some concern about the possibility of ratings agencies scarring America’s creditworthiness. There’s significant disagreement in the GOP about the prospects of default and downgrade, and some lawmakers believe the administration and congressional leaders have created a false panic to box them into voting to raise the debt ceiling.

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