U.S. Debt Downgrades Coming… Are Your Investments in Jeopardy?

I’ve made it plain for some time that the country’s deep financial problems are far beyond the political system’s capacity to address. And there is no candidate waiting in the wings with a practical plan to effectively walk America back from the consequences of decades of reckless spending and government expansion.
In the end, it will be the “spur” of a truly frightening dollar and debt crisis that will force true reform of government. And it will come, although you may expect the political class to use every tool at their disposal to fend off the ultimate crisis. The only real question is, when?
Congress Flubs Again, Won’t Even Slow GROWTH in Spending
The failure of the Capitol Hill “Supercommittee” to agree on a deficit-reduction plan confirms anew that Washington is dead-set on financial ruin. The more telling but less ballyhooed failure on Capitol Hill was that of the entire House of Representatives, which last week failed to pass a balanced budget amendment (it came up 29 votes short of the needed two-thirds majority).
Congress has had more than three months since Standard & Poor’s rescinded the U.S.’s AAA rating to come up with a credible plan to pare down untenable levels of deficit spending. In that time it has failed to enact even modest reductions in rates of spending growth, let alone make any actual cuts in bloated government programs we cannot afford.
Senator Patty Murray (D-WA), Deficit Supercommittee co-chair, attempted to analogize the government’s appetite for revenue to a family who summons the help of all members to pull through tough times. In an interview with CNN’s Candy Crowley, Murray let out this Freudian slip: “Big Brother has to be at the table.”
No, Big Brother needs to go on a diet!
In theory, $1.2 trillion in automatic rate-of-increase reductions (“cuts” in Washington speak) over 10 years will kick in anyway starting in 2013. In reality, Congress can substitute an alternative plan at any time, potentially to shield politically sensitive defense and entitlement programs from being subjected to lower rates of spending increases. It may even do so in December, before it adjourns for the year.
More Debt Downgrades of U.S. Debt Now Highly Likely
According to Morgan Stanley analyst Christine Tan, “If congressional action lessens the impact of the $1.2 trillion automatic trigger, we believe this could potentially provide S&P with a pretext to downgrade the U.S. further from AA+ to AA.”
Analyst Priya Misra suggests that Congress will need to come through with $2 trillion in additional spending reductions to avert another credit downgrade.
Fitch Ratings has confirmed that a “negative rating action” is possible if Congress fails to push through meaningful deficit reductions. If either Fitch or Moody’s join S&P in downgrading U.S. debt from AAA, some pension funds and mutual funds may be forced to dump Treasury securities.
In three to five years and beyond, if we don’t come up with a meaningful deficit plan, the bond market will punish us. I’ll guarantee you that,” Nariman Behravesh, chief economist at Global Insight warned. U.S. bonds could get punished much sooner than that, with little warning or notice, much like Greek, Italian, and now even “AAA” French bonds are.
Truth be told, U.S. debts are, by most important measures, worse than those of European “PIIGS” countries. Total U.S. government and agency debt now represents a frightening 118% of GDP – compared with just 60% of GDP for the troubled Mediterranean country of Spain.
And it could get much worse in 2012 before it theoretically gets “less worse” in 2013:
  • The Federal Housing Administration’s independent auditor reported last week that there is a 50% probability the agency will need another multi-billion-dollar bailout in 2012.
  • Social Security’s operating deficit could explode to $267 billion in 2012, budget analysts warn.
  • The government will borrow an estimated $541 billion in the first quarter of 2012 alone.
  • Any budget projections will worsen if the economy slides back hard into the recession from which it never fully emerged.
The fiscal train wreck that now appears unavoidable could induce even more extreme levels of monetary intervention. William Dudley, president of the Federal Reserve Bank of New York, hinted last week that new Fed purchases of mortgage-backed securities and other assets were likely.
He admitted that the Fed has been involved in trying to prop up not just the U.S. credit and housing markets, but the stock market as well. The Fed, he asserts, has “been effective in reducing long-term interest rates by basically helping support the stock market and housing values.”
Virtually nobody expects a dramatic rise in prices amidst this dire economic and financial backdrop, but if the Fed embarks on a full-scale effort to monetize Washington’s and Wall Street’s failures, that’s exactly what we’ll get.