US debt ceiling is a “potentially dangerous mechanism,” says Fitch

Credit rating agency Fitch Ratings is the most recent financial player to chide the US on the political instability surrounding the decision to raise the debt ceiling. In a note warning of a possible downgrade of its rating on US government debt, Fitch analysts said:

In Fitch’s opinion, the debt ceiling is an ineffective and potentially dangerous mechanism for enforcing fiscal discipline. It does not prevent tax and spending decisions that will incur debt issuance in excess of the ceiling while the sanction of not raising the ceiling risks a sovereign default.

Much like S&P, which axed the US credit rating in August 2011, Fitch’s rationale for threatening to lower its rating on US debt is political, not financial. Sure, Fitch acknowledges that the long-standing reputations of Treasury bonds and the US dollar as a safe place to put money “are being eroded by the large, albeit steadily declining, structural budget deficit and high and rising public debt.” But the warning centers on the fact that “a repeat of the August 2011 ‘debt ceiling crisis’ would oblige Fitch to review its current assessment of the reliability and predictability of the institutional policy framework and prospects for reaching agreement on a credible medium-term deficit reduction plan.”

This echoes the language from S&P’s downgrade of the US debt rating, which said:

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.

In the world of bonds, investors and academics often crack credit analysis of debtors into two halves.

The first is the ability to pay—i.e., can you come up with the cash to make payments to bond holders? On this point, the US clearly has the ability. The US can refinance its debt for decades at some of the lowest interest rates ever seen.

But the second component of creditworthiness is assessing the “willingness” of the debtor to pay the people it owes money. Essentially, this is a question of politics. And it’s clear from what Fitch and other ratings agencies are saying that the global opinion of US willingness to pay is being damaged by the recent debt-ceiling debates.

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