Shortly after markets closed on Tuesday, Fitch Ratings placed U.S. debt on Rating Watch Negative as a direct result of the political brinkmanship in Washington. The decision opens the doorway for a downgrade of U.S. sovereign debt — still currently rated AAA by Fitch — by the first quarter of 2014.
The heart of the matter is the ongoing debt ceiling debate. Testifying before Congress on October 10, Treasury Secretary Jack Lew outlined the dubious condition of the U.S. fiscal condition and drove home the point that come October 17 — barring action by Congress — the government will exhaust its borrowing authority and will have to rely on about $30 billion in cash on hand and incoming tax revenue to pay the nation’s bills. The government only takes in enough money to pay about two-thirds of its current obligations.
This notion has dominated the national conversation since October 1, when Congress failed to pass a budget (or a continuing resolution) and the government tripped into a partial shutdown. Since then, Washington has adopted the tactics of trench warfare. Democrats and Republicans, locked together in an awkward fiscal death dance by a bureaucratic Gordian knot, have found themselves in a type of brinkmanship in which political firepower greatly overpowers political mobility.
“Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default,” Fitch said when it placed U.S. debt on Rating Watch Negative. “The repeated brinkmanship over raising the debt ceiling also dents confidence in the effectiveness of the U.S. government and political institutions, and in the coherence and credibility of economic policy. It will also have some detrimental effect on the U.S. economy.”
In his testimony, Lew said that private-sector economists estimate the damage of a two-week shutdown to be a 0.25 percent reduction to fourth-quarter gross domestic product growth. Now that the shutdown is crawling into its third week and the toxic political situation has driven economic confidence into the ground, the damage could very well be greater.
“Some have warned that a longer shutdown would reduce economic growth as much as 1.5 percentage points,” Lew said. “These estimates typically do not include the additional spillovers that seem likely. Household and business confidence in the government could fall sharply, and other spending that relies on a functioning federal government could be postponed or cancelled.”
Observers are not taking the Ratings Watch Negative announcement from Fitch lightly. In 2011, after that round of debt-ceiling brinkmanship, Standard and Poor’s downgraded U.S. sovereign credit to AA+, one notch below the highest rating but still a massive blow. When the risk of default increases — perceived or otherwise — the cost of borrowing increases in turn, making U.S. debt more expensive to service.
So what hope is there for a deal? House Republicans appear fractious, and a recent proposal pushed forward by Representative Paul Ryan (R-Wis.), who chairs the House Budget Committee, was shut down by both houses. However, news broke on Wednesday morning when sources told CNN that the Senate had finally managed to hash out a deal that would reopen the government and extend the debt limit temporarily while setting up future negotiations.