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Why Geithner Can't Save Treasury Bonds

Secretary of Treasury Tim Geithner defended the Treasury bond's AAA rating yesterday on television. But what else could he do? Last Wednesday, credit rating agency Moody's warned that the T-bond's rating was in danger of a downgrade, which would be a disaster for Geithner and the Treasury. A downgrade would raise the cost of the nation's borrowing addiction, potentially hamstring the economic recovery and look really, really bad for Tim. So he did what he could to talk the spectre of a downgrade back into the closet. But it won't do any good. It's not his call.

Moody's was pretty clear about what had to happen to prevent a downgrade:

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.
In other words, the Treasury bond's rating is up to Congress, the strength of the recovery, and the analysts at Moody's and Standard & Poor's. How likely is it that Congress will get behind meaningful deficit reduction? Four days before Moody's fired its shot, Douglas Elmendorf of the Congressional Budget Office offered some dismal testimony about how much Congress would have to change. (Thanks to Ed Yardeni of Yardeni Associates for pointing out the testimony):
.... accumulating deficits will push federal debt held by the public to significantly higher levels. At the end of 2009, debt held by the public was $7.5 trillion, or 53 percent of GDP; by the end of 2020, debt is projected to climb to $15 trillion, or 67 percent of GDP.

...Moreover, CBO's baseline projections understate the budget deficits that would arise under many observers' interpretation of current policy, as opposed to current law. In particular, the projections assume that major provisions of the tax cuts enacted in 2001, 2003, and 2009 will expire as scheduled and that temporary changes that have kept the alternative minimum tax (AMT) from affecting many more taxpayers will not be extended.

...The baseline projections also assume that annual appropriations rise only with inflation, which would leave discretionary spending very low relative to GDP by historical standards. If the tax cuts were made permanent, the AMT was indexed for inflation, and annual appropriations kept pace with GDP, the deficit in 2020 would be nearly the same, historically large, share of GDP that it is today, and debt held by the public would equal nearly 100 percent of GDP.

In other words, Congress will not only have to cut spending-which it has shown no appetite for-but it will also have to forswear the annual tax breaks that a) it has always bestowed or b) that its members or the Administration have already said they plan to put into place.

If the U.S. loses its top credit rating, it certainly won't be the first nation so embarrassed. Japan just lost its top rating and the U.K. is on the bubble. University of Maryland economic historian Carmen Reinhart, told CBS MoneyWatch that financial crises have historically been followed by a wave of downgrades or inflationary patches. (See the interview below.)


The point is, downgrades of government bonds occur when government finances weaken to the point that thinking investors being to worry, even slightly, that the government's only way out is default or inflation. We're at or close to that point with U.S. Treasuries, and no amount of jawboning by the Secretary of the Treasury can pull us back. Only Congress can do that. Do you really think they're up to it?

More on MoneyWatch:

What's Wrong with the Recovery?
Bond Funds: Bubble Ahead
The $1.6 Trillion Deficit: Should You Be Afraid?

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