What’s
US debt crisis in a layman’s language?
Everyone
is talking about this new financial crisis. Stock markets all over the world
are plunging in response to the US debt crisis. In our country too, the
sensex is on a downward path since the time the news about this crisis
broke. Share values of Indian IT companies whose revenues are heavily
dependent on the US economy are falling steeply in the response.
What
exactly is this US debt crisis?
Why does a country borrow?
When a
country spends more than it earns through revenues, it has to borrow money
from the global market to meet the expenditure. The country also needs to pay
back the debt in installments over a period of time. This is called as debt
obligations. So once a country borrows, the expenditure of the country shoots
up. Hence the next time the country has to borrow more to meet not just the
expenditure but also the debt obligations. From this you can understand that
the countries’ debt amount goes on increasing with time as they borrow more
and more. United States is no different and is also under a huge debt of
$14.3 trillion at present. In fact, lending money to US is considered as a
safe and promising investment.
It is very
common for a country to spend more than its revenues. So it is
also normal for a country to borrow. In 2011 federal budget, the US
government estimated the expenditure at $3.82 trillion and revenues at
something more than $2 trillion. That implies a deficit of around $1.5 trillion.
Under normal situation, US govt. would have borrowed and compensated this
deficit. But they couldn’t because of the debt ceiling that is set by the US
Congress.
What is debt ceiling?
Debt
ceiling is a cap set by the US Congress on the amount of debt the government
can borrow. The limit was first set in 1917 at $11.5 billion. Whenever
the govt. reaches the ceiling, it can’t borrow more. Every time the cap is
reached the Congress approves a higher debt ceiling and directs the treasury
to borrow more. To raise the cap, a legislation has to be passed in both the
houses of the Congress: the Senate and the House of Representatives. The cap
was last raised to $14.3 trillion which the current govt. reached in May this
year. Since then the US is not being able to borrow more debt.
Why is the debt ceiling so
important?
The US government
has a legal limit on how much debt it can run up – $14.3tn at present. It reached the cap in May, which means
it cannot borrow any more money.
Wasn’t There a Commission About This in the US history?
Yes .That would be the bipartisan National Commission on Fiscal
Responsibility and Reform. Bye-Partisan. They proposed a six-part plan to put US on a path to fiscal
health, promote economic growth, and protect the most vulnerable among us.
But it the recommendations were not implemented…!
What would hav Happened If ‘US’ Default?
(from US point of view)
First,
if the deadline is not met, the country would likely enter a super serious
recession which would cause super bad chaos in the global economy. Bad things
would happen. Gloom would prevail. Goth bands would be taken seriously.
Second,
Experian, Equifax, and TransUnion would reduce the country’s credit ratings
from the 900s down to the 300s. The country couldn’t get a credit card, buy a
used car, or pay for hookers. Things would be grim. End times.
Third,
it would cost more for the government to borrow money. Higher interest rates
for mortgages, loans, and credit card balances. People will sell their gold
fillings, relatives, and body organs. Many Americans would move to Canada.
Fourth,
the country’s economic reputation would take a major hit in the markets,
creditors would demand higher interest rates, and investors would drop their
holdings in US dollars. The country would be renamed North Mexico.
How Does
This Affect a US citizen?
If your US Government defaults, it may
not be able to pay Social Security and Medicare benefits, military salaries,
interest on the national debt, tax refunds, or Groupons.
Why did not the US Congress raise the ceiling again and borrow?
This
is where the politics has come into the play. Raising the debt ceiling would
have been the obvious step as it has happened several times in the past: both
under the Democrats and the Republicans. But this time around the Republicans
(who are in opposition now) raised reservations over increasing the ceiling.
They did not agree to raise the ceiling unless huge spending cuts
without tax increase were agreed on. The Tea Party movement that started
in 2009 with a focus on reducing government spending and regulation
helped the republicans to win a substantial number of seats in the 2010
midterm elections. The Republicans fought the election on the planks
of cutting federal spending and stopping tax increases. Sticking to
those lines, they refused to support raising the debt ceiling unless
their demands were met. Since the Republicans control the House of
Representatives, the raising of debt ceiling could not be approved by the
house of Representative without their consent. President Obama and his
party is in minority in the house. So there was no other way left for the
Obama administration and they had to reach a settlement with the opposition
as quickly as possible.
What happened then? Did the two parties agreed on some settlement?
As
the US had already reached the debt ceiling in May, they needed to tackle the
issue immediately. It was apprehended that after August 2nd if the US govt.
couldn’t borrow, then US Treasury Department would have run out of money to
pay its bills. That could have resulted in widespread panic all over the
world because a large number of people and organisations receive payments
from the US.
At
the end, both sides agreed to control the deficit without raising taxes and
by spending cuts.
The House of
Representatives approved legislation to raise the U.S. debt limit by at
least $2.1 trillion and cut federal spending by $2.4 trillion or more.
So a catastrophic event was averted?
What is the outcome?
Yes, the result could
have been catastrophic if the cap wouldn’t have been raised. But the market
all over the world has reacted nervously and are worried over the US handling
of the debt problem. In an interesting development, USA lost its AAA
credit rating to AA+. In common language that means now lending money to US
is not safe (AAA rating means safe) and little risky. That also means the
interest rates will increase slightly making it difficult for the US to raise
money through debt. The current agitation in the financial markets are in
reaction to this developments.
Why will the crisis
don’t Impact much on India ?
·
India’s growth story is intact and
its fundamentals are strong.
·
We are in a better position than
many other nations to manage this challenge.
·
There could be some impact on the
capital and trade flows in the country.
·
We could notice FIIs seeing India
as an attractive investment destination even if there is any temporary
outflow since our fundamentals are strong.
·
We could rather see faster and
greater FII inflows, unlike after 2008,
in view of the higher returns that global investors could get in
India.
·
Softening of the international
commodity prices, especially fuel oil will help check inflationary pressures
in the economy.
RBI on the entire situation
 The RBI has said the country has sufficient
liquidity to manage a possible US sovereign debt default. The RBI is prepared
for any repercussions in the financial markets arising from any such
eventuality.
What is Standard & Poor's (S&P)?
It is a
United States–based financial-services company. It is a division of the McGraw-Hill Companies that publishes financial research and
analysis on stocks andbonds. It is well known for its stock-market indices, the US-based S&;P 500, the Australian S&;P/ASX
200, the Canadian S&;P/TSX, the Italian S&P/MIB and India's S&P CNX Nifty. The company is one
of the Big Three credit-rating agencies, which also
includes Moody's Investor Service and Fitch Ratings.
What are
Mortgages?
A
mortgage is a loan, commonly from a bank or a government-backed entity, that is
used to purchase a property. It can also be used to refinance a specific
mortgage or to cash out accrued equity on a property. A mortgage is a secured
loan as it takes the property for which it was issued as collateral.
America has had its credit outlook revised to negative
from stable by Standard & Poor’s Ratings Services.
(India’s
credit rating is ‘BBB minus’.)
But what
are credit rating agencies and how do ratings work?
What is a credit rating?
A credit rating is an opinion of
the general creditworthiness of individuals, companies and countries. Lower
credit ratings result in higher borrowing costs because the borrower is
deemed to carry a higher risk of default. A downgrade for America would mean
US bond investors would want to get paid more to compensate for the risk of
holding government debt.
What are sovereign credit ratings?
Sovereign credit ratings measure
the risk of investing in countries – political as well as economic risk. For
instance in Monday's statement S&P has pointed to the deficit as a risk
for investors in the US because Democrat and Republican policymakers have
still not agreed on a way to tackle it.
What is the role of credit rating
agencies?
Credit
rating agencies assess the risk of investing in corporations and governments.
The largest are Moody's, Standard and Poor's and Fitch Ratings. They also
provide a wide array of financial data and information on bonds, equities and
mutual funds.
How do they make money?
Agencies typically receive payment
for their services either from the borrower that requests the rating or from
subscribers who receive the published ratings and related credit reports.
How much weight does a rating
carry?
A lot of investment, such as
corporate and government bonds, must carry a credit rating. This has resulted
in credit rating agencies becoming very influential. However, their role in
the sub-prime crisis, when they rated various mortgage-backed financial
instruments that have subsequently been branded "toxic", has damaged
their reputation.
What do Standard and Poor's
"letter" ratings mean?
·
AAA -
Extremely strong capacity to meet financial commitments. Highest rating
·
AA - Very
strong capacity to meet financial commitments
·
A - Strong
capacity to meet financial commitments, but somewhat susceptible to adverse
economic conditions and changes in circumstances
·
BBB - Adequate
capacity to meet financial commitments, but more subject to adverse economic
conditions
·
BBB- (minus) -
this is the lowest rating before non-investment grade
·
BB: Less
vulnerable in the near-term but faces major ongoing uncertainties to adverse
business, financial and economic conditions
·
B: More
vulnerable to adverse business, financial to meet financial commitments
·
CCC: Currently
vulnerable and dependent on meet financial commitments
·
CC: Currently
highly vulnerable
·
C: A
bankruptcy petition has been filed or similar continued
·
D: Payment
default on financial commitments
Ratings in the 'AAA,' 'AA,' 'A' and
'BBB' categories are regarded by the market as investment grade.
Ratings in the 'BB,' 'B,' 'CCC,'
'CC' and 'C' categories are regarded as having significant speculative
characteristics.
Ratings from 'AA' to 'CCC' may be
modified by the addition of a plus (+) or minus (-) sign to show relative
standing within the major rating categories.
NR indicates that no rating had
been requested, there is insufficient information on which to base a rating,
or that S&P does not rate a particular obligation as a matter of policy.
What
is an outlook definition?
An S&P rating outlook assesses
the potential direction in which a rating will move over the next six months
to two years.
·
Positive - may be
raised.
·
Negative - may be
lowered.
·
Stable - unlikely
to change.
·
Developing - may be
raised or lowered.
·
NM - not
meaningful.
Lowering an outlook is generally
considered to be the first step towards a downgrade. S&P said: "Our
negative outlook on our rating on the US sovereign signals that we believe
there is at least a one-in-three likelihood that we could lower our long-term
rating on the US within two years."
S&P’s Downgrade of US Debt - 5
Reasons Why it is Wrong and Markets will Rebound
1)
Political Motivations
2) Poor Arithmetic or Malicious Intent
3) S&P’s Business Model
4) S&P’s Professional Incompetence
5) A Recent History of Defrauding
Investors
The first week of August, 2011 saw the world financial markets tumbling like a house of cards, the trigger
being the US debt downgrade by credit ratings agency Standard & Poor's. Stock markets across the globe
witnessed heavy panic selling between 1st and the 8th of August, 2011. The
biggest losers were the markets of Brazil and the USA, both losing 16.9% and
13% respectively. However, stock markets in India and China were relatively resilient
and declined by 8.1% and 6.6% respectively.
|
Chronology of events which need to
be taken into consideration for understanding the US debt crisis.
How the debt talks spiraled into crisis
November 2, 2010
Republicans win control of the House of Representatives on a
promise to scale back government spending and tackle budget deficits that
have hovered at their highest levels relative to the economy since the Second
World War.
December 1, 2010
A report by a bipartisan deficit-reduction panel commissioned
by US President Barack Obama advocates $3 trillion in spending cuts and $1
trillion in revenue increases - mainly by closing loopholes in the tax code -
over 10 years.
January 2011
Six Republican and Democratic senators, known as the
"Gang of Six", begin talks on a long-term deficit-reduction deal
they can present to their parties.
February 19
The House passes a budget for the current fiscal year that
would cut $61bon from last year's levels. The Democratic-controlled Senate
defeats it one month later.
April 9
Obama and congressional leaders bring the government to the
brink of a shutdown before they agree on a budget for the current fiscal year
that cuts $38bn from last year's levels. Billed as the largest domestic
spending cut in US history, it actually causes the government to spend $3.2bn
more in the short term.
April 13
After Obama's initial proposal is criticised as inadequate,
the President lays out a new deficit-reduction plan that would save $4
trillion over 12 years. He proposes that Vice-President Joe Biden lead
deficit-reduction talks.
April 15
The House passes a budget that would cut spending by $6
trillion over 10 years, in part by scaling back healthcare for the elderly
and the poor.
May 5
Biden and negotiators from both parties hold their first
meeting as top Republicans say there will likely be no broad agreement on tax
reform and healthcare.
May 9
House Speaker John Boehner, the top Republican in Congress,
says any increase in the debt ceiling must be matched by an equal amount of
spending cuts. The Treasury Department estimates it needs at least $2
trillion to cover borrowing through the November 2012 elections.
May 11
House Republicans release a spending outline for the coming
fiscal year that has its deepest cuts in education, labour and health
programs cherished by Democrats.
May 16
The US reaches its $14.3 trillion debt limit. The Treasury
Department begins tapping other sources of money to cover the government's
bills.
May 17
The "Gang of Six" talks falter as a leading
conservative, Republican Senator Tom Coburn, drops out due to an impasse over
healthcare.
May 31
The House of Representatives rejects a measure to raise the
debt limit in a vote staged by Republicans to pressure Obama to agree to
accompanying spending cuts. Senior Democrats decry the vote as a political
stunt, although 82 Democratic lawmakers join Republicans in defeating the
bill.
June 9
In a sixth meeting of the Biden group, Treasury Secretary
Timothy Geithner argues that tax increases need to be part of the equation,
but Republicans remain unmoved.
June 14
Some 34 Senate Republicans vote to repeal tax breaks for
ethanol, a sign that there may be some wiggle room in the party's
no-tax-increase stance.
June 23
Republicans declare an impasse in the Biden talks, saying that
Democrats are insisting on roughly $400bn in new revenue by closing tax
breaks for the wealthy and certain business sectors.
June 29
The International Monetary Fund says the US must lift its debt
limit soon to avoid a "severe shock" to global markets and a
still-fragile economic recovery. Obama calls for new steps to spur job growth
and tax hikes on the rich, irking Republicans who remain focused on deficit
cuts.
June 30
Democratic legislators discuss a scaled-back deal that would
avert default but force Congress to tackle the debt ceiling issue again
before the 2012 elections. The White House rejects the idea.
July 3
Obama and Boehner meet secretly to discuss a more ambitious
"grand bargain" that would save roughly $4 trillion over 10 years
through an overhaul of the tax code and changes to popular benefit programs.
July 5
Obama invites top lawmakers to the White House to restart
negotiations and clinch a deal by July 22.
July 6
Reuters reports that a small team of US Treasury officials are
looking at options to stave off default should Congress fail to raise the
limit. The Obama administration continues to say there is no contingency plan
in place.
July 7
After hosting lawmakers at White House, Obama says Republicans
and Democrats are still far apart on many issues but that all agree on the
need to raise the debt ceiling.
July 8
A dismal jobs report focuses new attention on the sputtering
economy. Obama says uncertainty about the debt ceiling talks is hurting
economic expansion.
July 9
Boehner says a "grand bargain" is out of reach
because Republicans will not accept the tax increases Democrats are
demanding, and he calls for a more modest $2 trillion package that would rely
mostly on spending cuts.
July 10
During a testy, brief meeting at the White House, Obama and
congressional leaders agree on little more than the need to meet again the
following day.
July 11
The follow-up meeting breaks little new ground, but Obama
pressures both Democrats and Republicans to make concessions that would clear
the way for a deal. Another meeting is planned for July 12.
July 12
Senate Republican leader Mitch McConnell offers backup plan for
raising the debt limit if there is no agreement on a broad deficit-reduction
plan. Obama warns that if the debt-limit impasse is not resolved soon,
government benefits for older Americans might be at risk after August 2.
July 13
Moody's Investors Service puts US on review for possible
downgrade given possibility that debt limit won't be raised in time. Obama
meets lawmakers for nearly two hours but a deal remains elusive.
July 14
Ratings agency Standard & Poor's says there is a
one-in-two chance it could cut the US's top-notch AAA credit rating if talks
remain stalemated. Obama suspends debt talks and gives party leaders 24 to 36
hours to deliver deadlock-breaking "plan of action".
July 17
McConnell and Senate Democratic leader Harry Reid work on
McConnell's fallback plan to allow Obama to raise the debt limit. Obama meets
Boehner and his deputy, Eric Cantor, secretly at White House but no progress
is made toward a deal.
July 18
Republicans push for a measure that would cut and cap
government spending and require an amendment to the US Constitution requiring
a balanced budget. Obama says he will veto it should Congress send it to his
desk.
July 19
The "Gang of Six" resurfaces with a deficit
reduction plan that proposes $3.75 trillion in savings over 10 years and
contains $1.2 trillion in new revenues. Obama seizes on it and calls on
leaders in Congress to start "talking turkey". House Republicans pass
a more drastic $5.8 trillion deficit-reduction plan with a balanced budget
amendment.
July 20
The White House signals Obama may be willing to accept a very
short-term debt limit extension beyond August 2 to give any agreed
deficit-cutting bill time to clear Congress. The President holds separate
meetings with top Democratic and Republican lawmakers.
July 21
Obama and Boehner are reported to be discussing a $3 trillion
deficit-cutting deal. Obama stresses some revenues will need to be included
in any accord. Obama meets with congressional Democratic leaders at the White
House, but there are no reports of a breakthrough.
§ July 22, 2011. The
Senate votes along party lines to table the Cut, Cap and
Balance Act; 51 Democrats voting to table it and 46 Republicans voting to
bring it to a debate. Senate Majority Leader Harry Reid called the
Act "one of the worst pieces of legislation to ever be placed on the
floor of the United States Senate." Even had it passed Congress, Obama
had promised to veto the bill.
§ July 25, 2011.
Republicans and Democrats outlined separate deficit-reduction proposals.
§ July 25, 2011.
Obama and Speaker of the House John Boehner addressed the
nation separately over network television with regards to the debt ceiling.
§ July 25, 2011. The
bond market is shaken by a single $850 million futures trade betting on
US default.
§ July 29, 2011. The Budget Control
Act of 2011 S. 627 ,a Republican bill that
immediately raises the debt ceiling by $900 billion and reduces spending
by $917 billion, passes in the House on vote 218–210. No Democrats voted
for it and it also drew 'no' votes from 22 Republicans who deemed it
insufficiently tough on spending cuts. It allows the President to
request a second increase in the debt ceiling of up to $1.6 trillion
upon passage of the balanced-budget amendment and a separate
$1.8 trillion deficit reduction package, to be written by a new
"joint committee of Congress."Upon introduction into the Senate in
the evening, the bill was immediately tabled on a 59–41 vote including some
Republican votes.
§ July 30, 2011. The
House of Representatives voted 173–246 to defeat Senate Majority Leader Harry
Reid's $2.4 trillion plan to reduce the deficit and raise the debt
ceiling.
§ July 31, 2011.
President Barack Obama announces that leaders of both parties have reached an
agreement to lift the debt ceiling and reduce the federal deficit, and
separately, House Speaker John Boehner told
Republicans that they have reached the framework for an agreement.Boehner
reveals details of the agreement in a presentation to the House Republicans.
§ August 1, 2011. The
House passes a bipartisan bill by a vote of 269–161. 174 Republicans and 95
Democrats voted 'yes'; 66 Republicans and 95 Democrats voted 'no'.
§ August 2, 2011.
§ August 2, 2011.
Date estimated by the Department of the Treasury that the borrowing authority
of the U.S. would be exhausted.
§ August 5, 2011. Standard & Poor's lowered the credit rating of the United States from AAA to
AA+,deciding that the budget plan that was passed did not go far enough to
address the country's debt. It also warned that it is pessimistic about the
nation's fiscal outlook.
§ August 9, 2011. The
U.S. Federal Reserve announces it will keep interest
rates at "exceptionally low levels" at least through mid 2013; but,
it also makes no commitment for further quantitative
easing.The Dow Jones Industrial Average and the New York Stock
Exchange as well as other world stock markets, recover after recent
falls. (Wall Street Journal)
Projected:
§ August 15, 2011.
$29 billion of debt interest becomes due. If this is not paid, the
United States technically would be in sovereign default.
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I liked one of my friend Santhi’s status
where he say’s
A drunk naked woman boards a cab in US. Driver of the cab, a
Gujju, keeps staring at her and does not start the cab.
Woman: Haven't you seen a naked woman before?
Gujju: cool down. I am not staring at you. I am just wondering where you have kept the money to pay me?
Learning: This is what
most of the American banks failed to do. Assessing the repayment capacity
before enjoying exposure. :D
