S&P's warning on deficits could strengthen 'gang of six'

The markets ultimately shrugged off Standard and Poor's downgrade on Monday of America's debt outlook, but the report's pointed criticism of legislative gridlock may give a boost to budget compromise efforts led by a bipartisan group of senators known as the "Gang of Six."

The ratings agency cited bipartisan bickering as the main reason for deciding to lower its outlook on the United States' creditworthiness from "stable" to "negative." The downgrade means, S&P added, that it thinks there is at least a one-in-three chance it could lower America's Triple-A rating in the next two years. The main reason: concern that political intransigence on both sides of the aisle will derail agreement on long-term deficit reduction.

"We see the path to agreement as challenging, because the gap between the parties remains wide," the agency wrote in its report. "We believe there is a significant risk that congressional negotiations could result in no agreement on a medium-term fiscal strategy until after the fall 2012 congressional and presidential elections." If that's the case, it added, the earliest possible agreement would affect the budget for 2014, and "a delay beyond that time is possible."

It was a clear warning shot, delivered shortly after Democrats and Republicans unveiled rival deficit-reduction plans that showed little more than the big gulf between the two sides.

If the United States actually did lose its Triple-A credit rating, an idea that would have seemed inconceivable before the financial crisis, Americans would probably see an immediate jump in interest rates. Even a small downgrade would set off anxiety. And because many institutional investors are required by their charters and sometimes by laws to hold Triple-A securities, a downgrade would reduce demand for Treasury securities.

Other things being equal, that would push up the cost of federal borrowing, which would add to the government's fiscal problems and also tend to push up interest rates for corporate bonds, mortgage debt, and other borrowing.

It's not clear yet whether the S&P warning will inject new urgency into the partisan warfare over deficit reduction. But Sen. Tom Coburn, R-Okla., a Gang of Six member, jumped on it as an opportunity to press his colleagues on reaching a compromise.

"Today's warning from S&P highlights the dangers of waiting for the perfect political moment to tackle our debt crisis," Coburn said in a statement. "It's time for both sides to drop their partisan talking points and decide what we can do together while we still control our own destiny. If we refuse to negotiate within our own government, we will soon find ourselves negotiating with foreign governments and the international financial community on terms far less favorable than we enjoy today."

The Gang of Six consists of Sens. Coburn, Kent Conrad, D-N.D.; Dick Durbin, D-Ill.; Mark Warner, D-Va.; Saxby Chambliss, R-Ga.; and Mike Crapo, R-Idaho. The group has been working toward producing a compromise deficit reduction plan modeled on the Bowles-Simpson plan released through President Obama's bipartisan commission last fall. The plan was harshly criticized on both sides of the aisle: Republicans abhorred its tax increases; Democrats hated its changes to Social Security.

It has often been said that only a crisis will drive the two parties to compromise. A National Journal survey of economic policy experts released on Monday found that most see dim odds for any agreement this year. And, certainly, the S&P's decision does not qualify as crisis, or anything more than perhaps a premonition of turmoil. But it could strengthen the Gang of Six's hand if it makes the specter of a downgrade more plausible.

The downgrade could also cause concern surrounding a related but more pressing issue: raising the U.S. debt ceiling. The U.S. government will run out of headroom in the next few months, and many Republicans have said they won't vote to raise the ceiling unless it comes paired with spending cuts. Republican lawmakers said that S&P's warning strengthened their arguments.

"Today's announcement makes clear that the debt-limit increase proposed by the Obama administration must be accompanied by meaningful fiscal reforms that immediately reduce federal spending," said House Majority Leader Eric Cantor, R-Va., in a statement. "For decades, Washington has blindly increased the debt limit while doing little to stop spending money that it doesn't have, a dangerous pattern that must end."

In fact, S&P didn't endorse the GOP platform of deep spending cuts and no tax increases. It merely insisted on the need for deficit reduction.

Nevertheless the Obama administration pushed back hard on S&P's conclusions.

"We simply believe that the prospects are better," said White House press secretary Jay Carney. "We think the political process will outperform S&P expectations."