Taking a Closer Look at the Result of a Credit Downgrade

A downgrade to the nation’s credit would probably increase the cost of borrowing for the federal government and for everyone else. But the Obama administration, House Republicans, some economists and Wall Street strategists have concluded that the economic impact would be surprisingly modest, one reason that negotiations over a “grand bargain” for debt reduction broke down.

The plans being debated instead by House Republicans and Senate Democrats would not reduce the federal debt to a level that most economists regard as manageable, and it seems likely that further efforts will await the results of the 2012 elections.

A compromise between the parties would avert the catastrophic consequences of default, but even if Congress agrees to pay its bills, one of the three credit rating agencies, Standard Poor’s, has said it may remove the United States from its list of risk-free borrowers.

“A downgrade has lots of downsides, but they’re minor in comparison to not raising the debt ceiling on time, so I think the focus is correct at this point,” said Mark Zandi, chief economist at Moody’s Analytics, a sister company to the rating agency that rates debt securities.

“What’s most important is raising the debt ceiling. That’s the minimum that they need to do to make sure the recovery in fact remains a recovery.”

Asked Thursday whether his plan would avoid a downgrade, House Speaker John A. Boehner said, “That is beyond my control.” He said the legislation, which the House passed Friday on a party-line vote, is “as large a step as we’re able to take at this point in time.”

President Obama warned Friday morning that the government was at risk of a downgrade, “Not because we didn’t have the capacity to pay our bills — we do — but because we didn’t have a AAA political system to match our AAA credit rating.” But administration officials say that the White House also regards the issue a secondary concern.

Earlier this month, there was widespread alarm in Washington when S P, followed by Moody’s and Fitch, another credit rating concern, warned that the soaring federal debt, and the political standoff over raising the debt ceiling, had placed the nation’s credit rating at risk.

The federal government makes about $250 billion in interest payments a year. Even a small increase in the rates demanded by investors in United States debt could add tens of billions of dollars to those payments. And the credit rating agencies have said other downgrades would follow like dominoes.

For example, Fannie Mae and Freddie Mac, the huge mortgage companies that are backed by the federal government, would be downgraded, raising rates on home mortgage loans for borrowers. Maryland and Virginia, and many local governments near Washington, their economies tied to the government, would also be downgraded. So would New Mexico, because an unusually high proportion of residents depend on federal benefits.

“A default on our nation’s obligations, or a downgrade of America’s credit rating,” 13 financial company chief executives said on Thursday in a letter to the president and Congress, “would be a tremendous blow to business and investor confidence — raising interest rates for everyone who borrows, undermining the value of the dollar, and roiling stock and bond markets — and, therefore, dramatically worsening our nation’s already difficult economic circumstances.”

Still, Washington’s fears of a downgrade have eased for several reasons.

Standard Poor’s warned that it might downgrade the United States in the next three months if the government did not agree on a credible plan to reduce its debts by about $4 trillion — the number used in the talks between Mr. Obama and Mr. Boehner.

But the other two agencies, Moody’s and Fitch, have shown greater patience, saying that progress toward paying down debts did not need to start immediately. That is significant, because a downgrade by a single rating agency matters less than a consensus. Investment managers, for example, may not be required to divest holdings like Treasury securities if they are downgraded only by S P.

Moody’s said on Friday that it would maintain its Aaa rating for the United States so long as the Treasury keeps paying bondholders and Congress passes a long-term deal to extend the debt ceiling. The announcement said that failure to act by Tuesday night, or to meet other obligations, including Social Security payments, would not prompt a downgrade.

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