Downgrade seen adding $100 billion to U.S. funding costs

NEW YORK Tue Jul 26, 2011 2:04pm EDT

NEW YORK (Reuters) - A downgrade of the United States' AAA credit rating is a bigger risk than a default and could over time add up to 0.7 percentage point to bond yields, members of a U.S. securities industry group said on Tuesday.

"That's on the order of $100 billion over time that we will add to our funding costs," said Terry Belton, global head of fixed income strategy at JPMorgan Chase. He was speaking on a conference call organized by the Securities Industry and Financial Markets Association, also known as SIFMA.

Over time, he said Treasury yields could rise 60 to 70 basis points on a credit downgrade -- "a huge number because we're talking a permanent increase in borrowing costs."

That would make it more costly for consumers and business to borrow money and could land the economy back in recession.

A default on the country's obligations would be even more disruptive, call participants said, and could ripple across financial markets, but was less likely.

The government hit its $14.3 trillion borrowing limit in May and the Treasury said it will run out of money to pay its obligations if the limit is not raised by August 2.

An increase has been held hostage to political squabbling. Republicans in Congress have refused to lift the debt ceiling without a long-term deficit reduction plan but remain at odds with the White House over the proper mix of spending cuts and tax increases needed to do it.

Belton said the odds of a default were "virtually zero," noting that there were enough tax revenues to tide the government over in case a deal is not struck by August 2.

Missing an interest payment "would be a far worse scenario and one I definitely think all members of the House and Senate would want to avoid," said Mike Hanson, senior U.S. economist at BofA-Merrill Lynch. He said it was "a low risk but, unfortunately, it is not zero."

FOREIGN DEMAND

Even if the debt ceiling is lifted and default averted, Standard & Poor's has said there's a one-in-two chance it could still cut the U.S. credit rating without a credible deficit reduction plan.

Investors think that means savings of $3 trillion to $4 trillion over 10 years. Republicans and Democrats are pushing competing plans, both of which fall short of that target.

In the short term, a downgrade would have a more subdued impact on markets, Belton said, with bond yields likely to rise five or 10 basis points.

Markets had feared a move to AA would spark forced selling, but Belton said "most investors have indicated they would be able to continue to hold them."

The "wild card" remains foreign demand over the longer run, sine the U.S. depends heavily on overseas investors -- mostly central banks -- to finance its deficit.

Belton said he expected demand for the $99 billion worth of fresh two-, five- and seven-year Treasury debt this week to be "on the weak side" and warned of even more concern if a debt ceiling impasse forces Treasury to postpone future auctions.

He said an eight-day auction delay surrounding a debt ceiling debate in 1995 cost the government 25 extra basis points in financing costs.

(Additional reporting by Emily Flitter; Editing by James Dalgleish)

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Comments (2)
DrJJJJ wrote:
Who in their right mind gives a AAA rating to an entity that spends more thaan $4Billion PER DAY than it takes in?

Over $10 Trillion in deficits is projected for the next 10 years and here’s the last 10:

2011 $1,500 Billion
2010 $1,300 Billion
2009 $1,400 Billion
2008 $240 Billion
2007 $161 Billion
2006 $248 Billion
2005 $319 Billion
2004 $412 Billion
2003 $374 Billion
2002 $159 Billion

Note: During 02-08 we had 911, 2 wars, Katrina, etc! What’s wrong with this picture-anyone? Yes, Clinton’s free home program ,record gov expansion and Bush2 issues did have a big effect on Obamas deficits-I’ll give him that! But, it’s time for change! (see above)

Jul 26, 2011 4:16pm EDT  --  Report as abuse
SeaWa wrote:
So those idiots arguing over politics will cost us 100 Billion MORE $$$, even as they are demanding that we CUT more expenses and refuse to end what was supposed to be TEMPORARY tax cuts and ridiculous loopholes!? IDIOTS. Their argument alone will end up costing us 100 Billion $$. Due to their argument, we may be downgraded even if we raise the debt ceiling on time!!!! That’s one expensive argument!

Jul 27, 2011 8:28pm EDT  --  Report as abuse
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