Agreement to Lift the Debt Ceiling and Reduce the Deficit Reached
admin | Tuesday, August 2nd, 2011 | No Comments »Agreement to Lift the Debt Ceiling and Reduce the Deficit Reached
A debt deal has been agreed to by the leaders of both houses of Congress and the President. This agreement will eliminate the possibility of a default by the United States on its obligations and reduce the deficit in two stages. According to a White House press release the agreement contains the following provisions:
- Implements 10 year discretionary spending caps that generate nearly $1 trillion in deficit reduction balanced between “defense” and “non-defense” spending;
- Increases the debt limit by at least $2.1 trillion and eliminates the need for an increase until 2013;
- Creates a bipartisan committee process to identify an additional $1.5 trillion in deficit reduction that will include entitlement and tax reform, and requires a Congressional vote on the recommendations by December 23, 2011;
- Has an enforcement mechanism that will trigger spending reductions that are evenly split between domestic and defense spending if the committee does not reach an agreement. Social Security, Medicare beneficiaries and low-income programs will not be subject to the cuts under the mechanism.
For more details on the agreement: http://www.whitehouse.gov/the-press-office/2011/07/31/fact-sheet-bipartisan-debt-deal-win-economy-and-budget-discipline.
Potential for Default Avoided but Downgrade in U.S. AAA Rating Still Looms
While a default by the U.S. has been averted and deficit reduction will occur, it is not clear if the deficit reduction and timeline are sufficient for the U.S. to avoid a downgrade in its AAA rating by the various ratings agencies. The agreement has several milestones that must be met:
- Congress must pass the agreement for the President to sign by August 2, 2011;
- Bipartisan committee must identify, agree and recommend an additional $1.5 trillion in deficit reduction to Congress;
- Both the House of Representatives and the Senate must vote on committee recommendations by December 23, 2011;
- Enforcement mechanism will be triggered for across the board cuts in 2013 if Congress does not reach agreement on the cuts.
Many believe that the agreement pushes the difficult decisions of how to reduce the deficit down the road, and wonder how a “bipartisan committee” with equal numbers will be able to agree on an approach that is best for the United States and not end up in a stalemate.
Potential Impact of a Downgrade
A downgrade in the U.S. AAA rating will have a ripple effect throughout the economy. The interest owed on the U.S. debt will increase, and states and localities will face increased borrowing costs as well. The debt deal is expected to keep mortgage interest rates and Treasury yields low. On August 2, 2011, a 30-year fixed rate mortgage had a 4.55% interest rate according to Freddie Mac’s Primary Mortgage Market Survey. If the U.S. AAA rating is downgraded, all of the agencies including Ginnie Mae, Fannie Mae, Freddie Mac, and the Federal Home Loan Banks that offer government-guaranteed financial products would also experience a corresponding downgrade. However, there continues to be debate over the level of impact of a U.S. rating downgrade on the financial markets and how it would be perceived.
Impact of Cuts on Economic Recovery and Housing Market
The housing recovery follows the economic recovery. Most economists agree that reducing spending during a period of slow growth is not ideal and will result in an additional slow down in spending. Various indicators reflect a very slow pace of economic recovery and low job creation. The “U.S. economy expanded at a slower pace than expected in the spring as consumers cut back on spending, while [GDP] revisions showed the slowdown this year was much more drastic than previously thought” according to the Wall Street Journal on July 29, 2011. The national unemployment rate is still above 9%, and the number of jobs created in June was anemic at less than 20,000. Jobs in the government, healthcare and education sectors are being eliminated as a result of decreased state and local government spending and budget limitations. The U.S. government is expected to reduce the growth outlook for GDP which is much lower than expected and will not support the job growth required to reduce the unemployment rate.
For more on the economic outlook and market reaction: http://www.nytimes.com/2011/08/01/us/politics/01econ.html and http://www.nytimes.com/2011/08/02/business/asian-markets-rally-after-us-debt-deal.html
International Reaction to the Debt Crisis and Agreement
The United States has lost some of its stature as a world leader and respect during the debt ceiling crisis. Reaction throughout the world has been negative to the “brinksmanship” and willingness of U.S. political leaders to risk default by not coming to an agreement and to threaten the economic health of countries throughout the world. Many were surprised and angered that the U.S. would take so long to increase the debt ceiling, and risk default and the economic health of not only the U.S. but the rest of the world. Concern has also been expressed about the “dysfunctional” nature of the U.S government on this issue and the acrimony revealed in the “divided government.” Russian Prime Minister Putin referred to the U.S. as a “parasite” that was infecting the rest of the world with its high deficits, and the China News Service referred to the actions of the United States as “irresponsible”. The New York Times reported that new head of the international Monetary Fund, Christine Lagarde noted “delicately” that the events of the past few weeks are “probably chipping into that very positive bias” the world generally has toward the U.S. and Treasuries.
For more on international reaction: http://www.nytimes.com/2011/08/01/us/politics/01capital.html
