On debt, Obama team pleaded with credit rating firms before downgrade warnings

Correction: An earlier version of this story incorrectly stated that a communication between a Standard & Poor’s analyst in

The Obama administration has mounted an intense behind-the-scenes campaign to keep the nation’s major credit rating companies from issuing threats that they might downgrade the United States over the swelling size of the federal debt.

Senior administration officials have been trying for months to convince analysts at the credit rating companies — all part of publicly traded firms — that political leaders in Washington can come to an agreement to tame the debt.

At one key moment, worried that news of a potential downgrade could wreak havoc on the markets, officials summoned four Standard & Poor’s analysts to a meeting with nearly every senior member of President Obama’s economic team at which Treasury Secretary Timothy F. Geithner made an impassioned plea against any action raising doubts about U.S. credit.

But S&P didn’t buy the argument — and one of the two other credit rating firms, Moody’s Investor Services, has expressed concern, too.

S&P has been the most dramatic in its threats, saying Thursday night that there is a 50-50 chance of a downgrade within three months. The firm warned that a failure by Washington to raise the federal debt limit by the Aug. 2 deadline could prompt a downgrade. But S&P didn’t stop there, laying out exactly how much political leaders have to cut from the budget deficit if they want to protect the U.S. credit rating.

If S&P were to reduce that top-notch rating, it could undercut the country’s financial standing in the world and its ability to borrow at extraordinarily cheap rates to fund the government’s operations.

Many investors around the world are required to hold only those investments with the highest ratings and could have to sell Treasury bonds if they are downgraded. Historically, Treasury bonds have been considered the world’s safest investments.

One company’s influence

The warning from S&P is striking because it reflects the tremendous leverage that a small group of financial analysts employed by a New York company — part of McGraw-Hill — has in insisting that U.S. leaders cut trillions of dollars from the federal budget.

John Chambers, a top S&P analyst, defended the company’s decision to threaten the U.S. credit rating, saying the company is consistently “tough.” He cited his firm’s earlier downgrades of Indonesia, Venezuela and Uruguay.

“We hold the mirror up to nature,” Chambers said in an interview. “Our working assumption is that this is the time to get a meaningful agreement by both parties. Once this moment passes, future moments will be more difficult to ascertain.”

Chambers said political leaders must agree to a plan to reduce the deficit by $4 trillion over 10 years to be certain of averting a downgrade. He said if leaders cut less than that — a scenario that appears more likely as negotiations over a larger deal have foundered — the country could still face a downgrade.

In Europe, which is already in the throes of a debt crisis, political leaders have taken aim at credit rating companies for their cutting the ratings of struggling governments.

Christine Lagarde, the new managing director of the International Monetary Fund and former French finance minister, said this year that “credit ratings agencies should not intervene and should not grade countries” in Europe that are working with the IMF or European economic officials to right their economies.

This is not the first controversy for the ratings companies, which review and assign ratings to securities issued by governments and private firms. The ratings companies misjudged many of the toxic mortgage-based investments that led to the financial crisis of 2008. Washington has subsequently sought to reduce the financial sector’s reliance on ratings.

So far, U.S. officials have not yet taken aim publicly at S&P or Moody’s for their warnings about the nation’s debt. Officials say only that the warnings are a reminder of the need for an agreement to tame the debt.

But behind the scenes, officials have tried to convince S&P that the political back-and-forth in Washington over the debt is mostly theater and that leaders have actually moved quite close to an agreement.

In February, S&P analysts told the administration they were beginning to more closely investigate whether the government could craft a plan to rein in the debt.

S&P analysts from London, New York and Toronto canvassed Washington, visiting members of Congress. The analysts detected deep divisions.

David Beers, who heads the unit that rates national economies, told senior Treasury officials that S&P was planning to issue the same warning to the United States that his firm gave Britain in 2009. The company had urged the adoption of a major austerity program. Britain followed that advice, winning S&P’s praise, though the spending cuts led to a significant slowdown in the British economy.

Administration officials told Beers in London that Obama’s team was working on an ambitious plan of its own.

Seeking to head off a setback for U.S. credit, Geithner summoned Beers and other S&P analysts to Washington at the Treasury Department hours after Obama publicly laid out a plan in April to reduce the deficit by $4 trillion over 12 years. Attending the meeting were Obama’s senior economic advisers: Geithner, Deputy Treasury Secretary Neal Wolin, budget director Jacob J. Lew, Vice President Biden’s chief of staff, Bruce Reed, and National Economic Council Deputy Director Jason Furman.

Administration overtures

Lew told the analysts that he had served as budget director in the Clinton administration during a prior round of contentious debate over the federal debt, according to a person familiar with the meeting. Just as that was resolved, he told the group, he believed both parties would now embrace an ambitious plan to rein in the debt.

“We discussed our firm belief that the government leaders will come together and will reach an agreement to address our long-term budget challenges,” Geithner later wrote in a letter to Rep. Randy Neugebauer (R-Tex.), chairman of a House Financial Services Committee oversight panel.

S&P analysts were not as sanguine and voted to put the United States on “negative” watch, meaning there were 1-in-3 odds of a downgrade.

S&P and Treasury officials continued to talk as negotiations over the debt limit and federal deficit escalated. But within the past week, political leaders have increasingly lost hope that they can reach a “grand bargain” to reduce the debt and may be preparing to settle for a more modest deal.

On Thursday night, S&P insisted that Washington must conclude an agreement to cut the deficit by $4 trillion or face the consequences of a potential downgrade.

Some experts doubt that the firm will carry out its threat.

“It could cause a lot of economic damage,” said John Hunt, an expert on credit rating companies at the University of California at Davis School of Law. “I’d be surprised, because they are aware of these potential consequences and they don’t want to blamed for them.”

Zachary A. Goldfarb is a staff writer covering the White House, focusing on President Obama’s economic, financial and fiscal policy.
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