- Allon Advocacy
The Implications of the Fitch Downgrade
While it may seem like a lifetime, it was in actuality just a little more than two months ago that, having reached a bipartisan deal to avoid breaching the country’s statutory borrowing limit, federal lawmakers patted themselves on the back and breathed a collective sigh of relief having salvaged the United States’ global economic standing. Without a debt limit deal, the country almost certainly would have faced financial calamity or, at the very least, a serious erosion of confidence about its credit worthiness.
While there was no default earlier this summer, last week the world learned that the United States government’s spending and borrowing habits – among other factors – had earned it a credit downgrade from Fitch Ratings. Specifically, on August 1, Fitch downgraded the United States’ “Long-Term Foreign-Currency Issuer Default Rating,” or IDR, from AAA to AA+. According to U.S. Global Investors, it was only the second time in history a ratings agency had downgraded the country’s credit rating. (The first downgrade came in 2011 when Standard & Poor’s lowered its rating due to Congress’ brinksmanship during the 2011 debt ceiling crisis.)
What are the potential consequences of Fitch’s decision and can federal policymakers do anything about them?
Let’s take a look. But, first, why did Fitch Ratings decide to take this significant action?
Why Fitch Ratings Downgraded the United States
One of the reasons that Fitch downgraded the United States’ rating was the fight over the statutory debt limit itself. But not just the most recent fight this spring. The last several – and those still to come. (According to the Peterson Institute for International Economics, Congress has brought the country almost to the debt ceiling brink at least 10 times over the last 13 years.)
In its announcement, Fitch Ratings said, “In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management. In addition, the government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process.”
As alluded to in that part of the statement, debt limit standoffs were not Fitch’s only concern with what’s happening in Washington, however. Readers may recall that, during this spring’s debate about raising the federal debt limit, Republican lawmakers argued the federal government was spending too much and taking on too much debt.
It appears Fitch Ratings agrees. In its announcement, Fitch said, “The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years [and] a high and growing general government debt burden.”
The outlook is, indeed, bleak. According to the announcement:
The U.S. national debt-to-gross domestic product (GDP) ratio will run 112.9 percent for 2023, a number that is “well above the pre-pandemic 2019 level of 100.1 percent.”
Without action, the country’s debt-to-GDP ratio will rise to 118.4 percent by 2025, a ratio that “is over two-and-a-half times higher than the ‘AAA’ median of 39.3 percent of GDP and ‘AA’ median of 44.7 percent of GDP.”
The federal government’s annual budget deficit will rise to 6.3 percent of total GDP this year from just 3.7 percent in 2022 due to “cyclically weaker federal revenues, new spending initiatives and a higher interest burden.”
The federal government will run an annual budget deficit of 6.6 percent of GDP in 2024 and 6.9 percent of GDP in 2025. Those gaps “will be driven by weak 2024 GDP growth, a higher interest burden and wider state and local government deficits,” Fitch said.
State and local governments are expected to run an overall deficit of 0.6 percent of GDP in 2023 after running a surplus of 0.2 percent of GDP last year.
The agreement Congress reached in June apparently will not be enough to improve this outlook. Fitch concluded, “Cuts to non-defense discretionary spending (15 percent of total federal spending) as agreed in the Fiscal Responsibility Act offer only a modest improvement to the medium-term fiscal outlook” and warned it “does not expect any further substantive fiscal consolidation measures ahead of the November 2024 elections.”
As if all of these factors were not enough, Fitch also said it expects the United States to fall into recession in the next year or two.
Again, pretty bleak.
What Are the Consequences of Fitch’s Decision?
U.S. Treasury Secretary Janet Yellen tried to downplay the impact that Fitch’s decision could have on the U.S. economy and on Americans. In a statement, Secretary Yellen argued, “Fitch’s decision does not change what Americans, investors, and people all around the world already know: that Treasury securities remain the world's pre-eminent safe and liquid asset, and that the American economy is fundamentally strong.”
Some economists agreed. Gus Faucher, senior vice president and chief economist at PNC Financial Services Group, told NBC News that, in the immediate term, not much will change for most Americans. “For most consumers, it’s a nonevent,” Faucher said.
Still, Fitch’s decision is significant — and could have substantial consequences over the long-term. The first of which are higher borrowing costs. As CNBC noted, interest rates for mortgages and credit cards are likely to rise for consumers (at the same time the Fed is raising its benchmark rate).
Higher borrowing costs also could mean the U.S. government may have “to pay more interest on its new debt issues, further deepening its debt burden,” U.S. Global Investors said. (That is problematic since the federal government already shells out nearly $1 trillion in interest payments on its debt annually, or about one-third of what the Treasury Department collects in taxes.)
U.S. Global Investors said the downgrade also could lead to:
Currency devaluation if foreign investors opt to sell off their holdings;
Short-term volatility in stock markets; and
Reduced investor sentiment overall.
Shai Akabas, director of economic policy at the Bipartisan Policy Center, told ABC News the federal government also “could then lose some of its ability to spend on social welfare programs and projects that help stimulate the economy, which in the long term could slow economic growth and leave the nation vulnerable to financial setbacks.”
Can Federal Policymakers Do Anything About Fitch’s Decision?
Outside of enacting legislation to cut spending and/or raise taxes considerably, federal policymakers cannot do much to improve the current situation. Indeed, Fitch’s only suggestion for bringing back a better rating is to implement “a fiscal adjustment to address rising mandatory spending or to fund such spending with additional revenues, resulting in a medium-term decline in the general government debt-to-GDP ratio.”
“Mandatory spending” in this context means some of the programs on which older and more vulnerable Americans rely, such as Social Security, Medicare, and Medicaid — programs that Congress generally has been reluctant to change regardless of which party is in charge. In fact, the last major change to Social Security came in 1993 when President Bill Clinton signed the Omnibus Budget Reconciliation Act, which raised the share of Social Security benefits that are subject to income tax from 50 percent to 85 percent for beneficiaries with incomes of more than $34,000 for single taxpayers or $44,000 for a couple filing jointly.
In a sign of why changes to these programs are so politically toxic, that omnibus package, which included a host of other tax increases, was a central aspect in Republicans’ campaign against Democrats in the 1994 midterm elections. That year, Democrats lost control of the U.S. House of Representatives for the first time in 40 years.
Readers also may recall that President Joe Biden accused Republicans in his 2023 State of the Union address of having a secret plan to cut Social Security (something GOP lawmakers said was a lie). And when he rolled out his fiscal year 2024 budget in a speech this past winter, President Biden said, “I guarantee you I will protect Social Security and Medicare without any change.”
As noted above, Fitch’s downgrade is only the second the United States has endured. Standard & Poor has yet to restore its credit rating for the United States — and Congress clearly did not respond to the Standard & Poor’s decision by cleaning up its act and avoiding future fights over the statutory debt limit or righting the fiscal ship.
In other words: last week’s decision by Fitch Rating is unlikely to result in any real action on Capitol Hill, especially if Treasury Secretary Yellen and economists like Gus Faucher are correct and the impact on consumers, investors, and taxpayers is limited.
Where we may see a change is in Election 2024 rhetoric.
Indeed, as The Hill reported, both parties are already trying to pin blame for the downgrade on one another.
“The Fitch Ratings credit downgrade is a wake-up call that Bidenomics doesn’t work,” Rep. Don Bacon (R-Neb.) wrote on social media. “Congress must assert its power of the purse to resolve this concern and restore faith in U.S. financial institutions.”
Predictably, White House Press Secretary Karine Jean-Pierre defended the president and said, “It’s clear that extremism by Republican officials, from cheerleading default to undermining governance and democracy to seeking to extend deficit-busting tax giveaways for the wealthy and corporations, is a continued threat to our economy.”
Based on these statements, Fitch’s prediction from last week appears prescient: even in the face of a dire credit downgrade, do not “expect any further substantive fiscal consolidation measures ahead of the November 2024 elections.”