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Credit Downgrade Brings Problem Areas Into Focus

Reena Aggarwal

August 24, 2011 In early August, Standard & Poor’s downgraded the U.S. credit rating from its elite AAA status to AA+ for the first time in history, setting off a heightened wave of concern over the nation’s economy. The credit rating agency said the U.S. fiscal plan fell short of what’s necessary to “stabilize the government’s medium-term debt dynamics.” It also cited concern over July’s bitter debt-ceiling battle between Congress and the White House. Reena Aggarwal, the McDonough Professor of Business Administration, says the nation’s credit rating may have been decreased, but the United States is far from going into default on its debt. Standard & Poor’s downgrade merely put focus on an economy hemorrhaging from a lack of decision-making in Washington, she says. The financial scholar compares the financial crisis of 2008 to today’s crisis and talks about the crippling power of uncertainty on the nation’s recovering economy.

What impact has Standard & Poor’s recent downgrade had on the U.S. economy?

It’s not so much about the downgrade itself. There’s no question there’s tremendous weakness in the economy, but Standard & Poor’s downgrade in a way did help us focus our attention on the fact that something needs to be done soon. It got the attention of Capitol Hill and the White House.

Does the lower credit rating mean the United States is a risky investment?

I have to be very clear. There is absolutely no risk of the United States defaulting on its debt. U.S. solvency is not a problem. If you look around the world we’re not the only ones experiencing economic hardships. Europe is in worse shape. Countries like China and India that were growing at really good pace are starting to have their problems. They have to worry about inflation.

Do you believe Standard & Poor’s low rating of the United States was an attempt to regain credibility?
That’s what some have said. Rating agencies such as Standard & Poor’s, Moody’s Investors Service and Fitch Ratings had been lagging behind in updating ratings for governments and companies. We’ve seen that on a number of occasions. The agencies weren’t always reflecting what was really going on in the markets.

Now, they're alert, and they’re trying to stay ahead of the curve. But I really think the discussion needs to be about the global economic issues rather than the blame game.

What major issues are facing the U.S. economy?
We need to address issues such as the budget deficit national debt, unemployment, housing and economic growth.

At this stage, the ball is in Washington. We have a huge debt problem, a huge deficit problem, and yet there is no plan of action.

Last month, we saw Washington breaking down during the debt-ceiling talks. If it were any company operating like this, Congress would have had a thousand hearings by now, and the CEO would have been fired.

People don’t want to invest. They don’t want to spend. Companies are sitting on a lot of cash because they don’t want to invest due to the uncertainty in Washington in solving the deficit problem. Companies are waiting on the sidelines, focusing on cost-cutting rather than investments.This lack of investment hurts our global competitiveness. Individuals have become very careful in this uncertain environment and are holding back on spending. A plan needs to come out of Washington soon.

All this uncertainty makes people feel poor as they watch the swings in the financial markets. They see their net worth go down along with the value of their 401K retirement plans. Consumers are concerned about jobs and also the value of their portfolios going down. It affects consumer sentiment negatively. So, consumer spending is not going to help us out of this recession.

How does the current economic crisis compare to the one in 2008?
The banking sector is sort of the foundation for any economy. In 2008, the banking system wasn’t working. Companies took on too much debt, bad loans were an issue and credit markets were frozen. We were on the brink of disaster.

The government had to intervene with federal stimulus dollars, but that also meant the government incurred a huge budget deficit. I completely understand why the government had to pour economic stimulus dollars into the economy, but it now has to have the political willpower to figure out how to reduce this high debt and budget deficit.

How will the 2012 elections play a role in sparking political willpower needed to boost the economy?

The economy is center stage for the presidential elections. My concern is that the hard decisions won’t get made. The willpower to really address tough issues is lacking, and we don’t really have the luxury to wait until after the election.

It will take longer for us to get this problem behind us. It’s much better to take decisive action. Send the signal loudly that this is what we’re going to do instead of allowing the slow bleeding of the economy.

What happens if there isn’t swift action by the government?

At some point inflation is going to go up, and we will be dealing with a weak economy at the same time. When inflation goes up, interest rates will go up. People will be less likely to buy houses and cars. Companies will raise capital at a higher cost, and this will affect more jobs. The concern tends to be that there will be stagflation – a combination of a stagnant economy and inflation. So you will have the worse of both worlds. There will be a tipping point and global investors may lose confidence in the US economy.
 

There’s no easy solution. Even if Washington gets its act together, which is a prerequisite, it’s not like things will turn around tomorrow. If we leave politics aside and make the difficult decisions then in two or three years the economy will look much better. The U.S. economy is a vibrant one, and we should be able to deal with the current problems.
 

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