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Moody’s And Bernanke Warn Of U.S. Budget Deficits And Related Credit Rating Problems

Expert Witness: Fulcrum Inquiry
Moody’s warned that it might pull the federal government’s triple-A credit rating if President Obama’s recently-released budget is implemented. Last week, Fed Chairman Ben Bernanke gave similar serious warnings about the same budget.

In the beginning of February, Moody’s Investors Service warned that the triple-A sovereign credit rating of the United States would come under pressure unless either economic growth was greater than expected, or the nation’s budget deficit was reduced. Moody’s stated:

“Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in the projections for the next decade will at some point put pressure on the triple A government bond rating.”

The Moody’s warning came in response to the Obama Administration
budget that had just been released. The 2010 budget showed an even larger budget deficit ($1.6 trillion) than what is being estimated for fiscal 2009 ($1.4 trillion). Since no one can probably really understand what a trillion dollars is anyway, percentages might be more useful. Fiscal 2009’s budget deficit is estimated as 9.9 percent of the nation’s gross domestic product (GDP). The Obama Administration is proposing that the budget deficit be increased to 10.6% of GDP currently. This proposed deficit will increase the U.S. government’s public debt to approximately 64% of GDP from 53% of GDP just the preceding year. These ratios of budget deficits are the highest ratios since the Second World War.

These projected deficits already take into account significant tax increases that President Obama is proposing on business and the “rich” in this budget. In other words, deficit reductions will not occur through tax increases on the normal targets, since these tax increases are assumed to have already occurred in the President’s budget.

Perhaps more ominous, the budget deficits are not a short-term phenomenon caused by the recession. The projected deficit as a percentage of GDP is forecast as 8.3 % in 2011, and 5.1% in 2012. After the economy has fully recovered, President Obama proposes budget deficits at around 4% (rounded) for the entire forecast period which ends in 2020. By 2020, debt as a percentage of DGP is forecast at over 77%, more than double when President Obama took office.

Moody’s comments that these federal debt levels substantially understate the overall American government debt problem because additional debt exists at the state and local government levels. Consequently, the federal debt levels cannot be directly compared to debt levels of other governments since other governments do not have the substantial debt occurring at lower levels of government in the U.S. According to Moody’s:

“Using the general government measure, including state and local governments as well as the federal government, which is used internationally, this ratio would be well over 100 per cent in 2020.”

While the rest of the county focused on President Obama’s health care summit, Fed Chairman Ben Bernanke was making uncharacteristically candid comments regarding the need to shrink these soaring budget deficits. Last week, Federal Reserve Board Chairman Bernanke provided two days of testimony in connection with the Federal Reserve’s “Semiannual Monetary Policy Report to Congress”. Bernanke appeared before the House Financial Services Committee on Wednesday and the Senate Banking Committee on Thursday. Under questioning, Bernanke repeatedly delivered the message that the current budget projections of the Obama administration were “unsustainable”. In order to keep public debts from spiraling out of control, Bernanke said:

"A rule of thumb is that … you need to have deficits more on the order of 2.5 to 3 percent" of GDP.”

Bernanke indicated multiple times that failure to reduce the deficit levels to below 3% of GDP levels each year would have a short-term impact on the economy in the form of rising interest rates and a serious decline in the value of the dollar. Representative of his concerns is the following comment made before the House Financial Services Committee:

“One risk that I’ve described is that if there’s a long-term loss of confidence in the long-term ability of the government to balance its affairs that could raise interest rates today, which would have a drag effect on the economy. Another possibility, which I think is relatively unlikely, but it’s certainly possible, is that if there’s a loss of confidence in the government’s ability to achieve fiscal stability…the dollar could decline, which would have a potential inflationary impact on the economy.”

In response to a question during the Senate testimony about how quickly the current level of U.S. budget deficits would “become a major problem in terms of the economy,” Bernanke responded:

“It could become a problem tomorrow if bond markets are not persuaded that Congress is serious about bringing down the deficit over time.”

Bernanke’s warnings are hardly the words of a partisan politician. At this point, Bernanke is an Obama appointee. Bernanke was an active leader and proponent of strong government action to avert what he saw as greater problems earlier in the recession. His and Moody’s warnings to reduce the budget deficit need to be taken seriously.

Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials: CPA, MBA, CMA and ASA.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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