S&P: U.S. Faces Further Downgrade Beyond AA+

The U.S.s new double A+ rating could go down more in a time frame of six months to 24 months, to double-A, depending on government action to cut the deficit, John Chambers, managing director and chairman of Standard & Poors sovereign ratings committee tells FOX Business senior vice president and anchor Neil Cavuto in an interview on FOX News Saturday.

That means the U.S. government effectively has until at least February to find additional cuts to meet S&P's demand for at least $4 trillion in total deficit reductions over the next decade. The debt ceiling deal cuts $917 billion over the next decade and at least $1.5 trillion from a new bipartisan super committee in Congress by November.

For the first time in history, Standard & Poors downgraded the U.S.s vaunted Triple-A rating to double A+ after the markets close on Friday night, a rating it has held at S&P since 1941.

The rating was dropped to double-A+, S&P says, because of its deepening concern that Washington, D.C. cannot get a grip on the nation's finances in the mid to long-term, as well as fears that the economy could weaken, and that interest rates could spike higher, causing interest costs on the debt to rise.

S&P also cited a weakening federal revenue picture as part of its reasons behind its downgrade.

The threat of another drop by at minimum February 2012 throws a wrench into any possible plans by the Administration to revive job growth via more federal stimulus spending, as a re-election year approaches and the economy has hit stall speed at average annual GDP growth trending at 2% for 2011.

The U.S. jobless rate dropped to 9.1% from 9.2%, new data released on Friday show. An estimated 193,000 workers dropped out of the workforce, driving the rate lower. The White House has been mulling a plan for an infrastructure bank, which would create jobs to rebuild the nations highways and bridges, among other ideas.

Chambers declined comment on reports that the Administration had pressured S&P to not execute a downgrade.

The Administration has always conducted itself with the utmost professionalism, Chambers told Cavuto in the interview. When asked about Congressional reaction, Chambers said: The only pushback we got were negative emails from people I don't know.

S&P in recent weeks put the U.S. on a fast-track for a downgrade, upping the odds to 50-50 from a one in three chance it had reiterated last spring. Chambers cited "acrimonious" D.C. debt fights that were worse than the company had expected as detrimental to the rating in a conference call with clients last week.

And although downgrades usually come from external shocks to an economy, the U.S.'s downgrade is "a self-inflicted" problem, S&Ps Chambers has said.

When asked why it downgraded, S&Ps Chambers told Cavuto in an interview on FOX News Saturday morning that political gridlock in Washington, D.C. makes us think it would be difficult for elected officials to put the deficit on a sustainable path.

Chambers also confirmed a controversial decision by S&P to include debt at the state and local level, which he says, along with federal debt, has been on an upward path.

Including state and local debt in its decision to downgrade is controversial, because state and local officials have the authority to cut spending or raise taxes on their own to restore fiscal health.

And Chambers confirmed that $4 trillion in cuts over ten years was a sticking point. The U.S. Congress recently agreed to $917 billion in deficit reductions. S&P's new double-A threat puts pressure on the new 12-member bipartisan committee to slash the 10-year deficit by another $1.5 trillion come November. If they fail, if Congress rejects or the President vetoes, spending would be cut an automatic $1.2 trillion, including 2% reductions to Medicare providers.

But those planned reductions would not be enough for S&P. It wants at least $1.6 trillion more in cuts, beyond what the bipartisan commission has been ordered to come up according to the new deal.

The downgrade caught Wall Street by surprise, and rattled investors after a week that saw the Dow Jones Industrial average post its biggest loss in two years. The Dow dropped 512.76, erasing the year's gains. It is now in correction mode.

The move also stunned top government and Wall Street executives. Top-level officials at the U.S. Treasury Dept., the New York Federal Reserve and at primary dealers on Wall Street, including JPMorgan Chase, Goldman Sachs and Pimco, "did not believe a downgrade was imminent," according to minutes of a routine meeting on August 3d.

Even so, S&P is sticking to its demands for $4 trillion in debt cuts.

If you get to $4 trillion mentioned by the President in an April 13 speech, by the Bowles-Simpson commission and by Congressman Paul Ryan, that along with economic growth wouldve done the trick to preserve the triple-A, he told Cavuto.

Chambers in the conference call with clients last week said the $4 trillion was just a start, calling it a good down payment.

Chambers told Cavuto that the fiscal, political, and monetary outlook were not as strong as S&P liked, evidenced by the debt ceiling fight and cash management problems shown at the Treasury.

The ratings agencies have been criticized for being too slow to downgrade worthless subprime mortgage-backed securities they had given top-notch triple-A status.

All of the credit ratings agencies had also been criticized for being too slow to downgrade debt from the likes of Enron Corp. and WorldCom, despite their deteriorating balance sheets after accounting frauds at the companies were discovered.

When asked about the subprime rating controversy, Chambers said to Cavuto that S&P has been rating bonds since the 20s, it has a track record of over 100 years, and that it applies the same standards to all of the countries it rates.

Five countries lost but regained their triple-A over the course of nine to 18 years, Chambers noted in his interview with Cavuto.

The final decision to downgrade the U.S. to double A+ came mid to late Friday morning eastern standard time, says a source at Standard & Poors.

The credit ratings agency has departed from the reaffirmation of the U.S.s triple-A by Moodys Investors Service and Fitch Ratings, a reaffirmation that came in and around Aug. 2 when the President signed the debt ceiling increase into law.

An error in S&Ps math sent officials at the Treasury and the Congressional Budget Office scrambling. S&P was found to have made an estimated $2 trillion error in its ten-year deficit projection.

But S&P had already committed to the downgrade, despite the error, due to instability in the fiscal process in D.C. and the fact that cuts fell short of its $4 trillion in demands.

S&P delayed the announcement of a downgrade after discovering its error, in order to hold an emergency conference call to consult with its full sovereign wealth committee, including members in Europe and its primary analyst in Canada, a source close to the matter says.

The conference call was held before U.S. markets closed Friday, and after it had hashed out the error with officials at the Treasury Dept. and the Congressional Budget Office, the source says. S&P officials in Europe "concurred" with S&Ps decision. All agreed "we were looking for $4 trillion in cuts" a source close to the matter says.

S&P then contacted Treasury "within hours" of its full committee meeting to tell U.S. Treasury Secretary Timothy Geithner, White House officials and Federal Reserve officials of the downgrade.

S&Ps standard practice is to issue a downgrade "within 12 hours" of a warning to avoid insider trading on Wall Street.

The error came to light after U.S. officials told S&P it had a $2 trillion math mistake over a 10-year period. That error inflated S&Ps initial debt to GDP ratio to 87%.

S&P then issued a statement last night indicating instead of a 10-year time frame for assessing the creditworthiness of the U.S. rating, it is using a shorter time frame of three to five years to ascertain the countrys creditworthiness.

Using that time frame, and based on new assumptions, S&P concluded that by 2015, the U.S. net general government debt hits $14.5 trillion, or 79% of GDP in 2015, versus $14.7 trillion or 81% of GDP in 2015, based on its initial assumptions a difference of $345 billion.

Despite this two percentage point swing, S&P said in a statement it decided to downgrade because "the primary focus remained on the current level of debt, the trajectory of debt as a share of the economy, and the lack of apparent willingness of elected officials as a group to deal with the U.S. medium term fiscal outlook.

It added that the math error didnt affect its rating decision. It said in a statement: None of these key factors was meaningfully affected by the assumption revisions to the assumed growth of discretionary outlays and thus had no impact on the rating decision."

All eyes are now on the Federal Reserve policy meeting this coming Tuesday, and on Wall Street, where officials there are debating how the downgrade could affect yields on the 10-year U.S. Treasury note. Yields could spike higher by anywhere from .07% to .60%, based on Wall Street estimates. Any rise would means borrowing rates for mortgages and credit cards could rise too, dampening an already hurt housing market and sluggish consumer spending.

But because the U.S. is still seen as what's called a safe haven, U.S. Treasuries have been trending below 3% at historic lows in trading, so rates may not bounce higher by much from the downgrade.

According to a report from Dan Greenhaus, chief global strategist at BTIG, a financial services firm, obtained by FOX Business anchor Cheryl Casone, Greenhaus indicates the downgrade probably doesnt mean much although the fact S&P maintains its negative outlook is worrisome.

Greenhaus notes that when S&P put the U.S. on credit watch negative on April 18, that announcement sparked a sell-off in bonds that was subsequently erased later that day. Greenhaus adds that a weakened economic environment in which there are little alternatives to U.S. Treasuries will support the market in the immediate term. Greenhaus believes the downgrade is likely worth 7-12 bps (basis points).

Yields on the 10 year note fell to 2.33% Friday, and finished up closer to 2.60%, driven down by investors fleeing Eurozone debt, among other things.

Greenhaus also says that Belgium, Italy, Spain, Japan, Canada and Ireland all lost their respective Triple-A with little effect on yields outside of an immediate spike. The Japanese 10-year offering is sticking right around 1.00%.

And he says, based on information from Canadas Department of Finance, that the loss of the Triple-A rating might be a blessing in disguise.

Canada lost its Triple-A in 1994. Canada then embarked on an aggressive, long-term plan to balance its budget. It then moved into annual budget surplus by 1997and regained its Triple-A rating, Greenhaus says.

However, while the medium- to long-term picture for the U.S. is troublesome, its immediate deficit is less so, Greenhaus says.

He adds that from the rating agencys point of view, the focus on discretionary spending has been misguided with little progress made on the longer term problems surrounding health care and defense.

By 2021, around 80% of expenditures will be for Medicare, Medicaid, Social Security, Defense and Interest on the debt, up from less than 70% today, he says. Perhaps the super committee will now be pressured to tackle some of the more systemic issues in the deficit, Greenhaus says.

If bond prices fluctuate dramatically lower in a bear run, that could spike yields higher. Talk flew on Wall Street even before the downgrade that the Federal Reserve might have to step in again as the market downdraft vaporized more than $1.8 trillion out of the value of U.S. stocks. Question now is whether the Federal Reserve would have to step in again and buy Treasuries to keep a lid on interest rates, if bond yields rise next week and beyond.

Here are key points from the minutes of the meeting of the Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association held on 8/3/2011. Note: the meeting was held before the downgrade.

Present at the meeting were assistant secretary for financial markets Mary Miller; deputy assistant secretary for federal finance Matthew Rutherford, and director of the office of debt management Colin Kim and eight other Treasury department officials.

Federal Reserve Bank of New York members Brian Sack and Joshua Frost were also present, as well as primary dealers from Wall Street.

According to the minutes, officials discussed the following: --"Uncertainty over fiscal policy more elevated than at any other time in modern memory..uncertainty engendered by (debt ceiling) debate may have lingering adverse consequences for business and consumer sentiment. --Noted debt ceiling hike will increase debt to $14.7 trillion. --Discussed the dollars reserve status. Noted other countries have longer Treasury maturities, and the U.S.s shorter maturities (that indicates a concern about rollover risk, which means yields could spike higher in the short term). --Noted the "idea of a reserve currency is that it is built on strength, not typically that it is best among poor choices..The fact that there are not currently viable alternatives to the U.S. dollar is a hollow victory and perhaps portends a deteriorating fate." --Expects the Federal Reserve to keep its policy on hold re: its upcoming meeting this Tuesday. --Says "disappointment in growth and the easing in inflation have pushed back expectations regarding the timing of the Federal Reserves exit from its current accommodative stance." --Notes "Chairman Bernanke has recently mentioned the possibility for further monetary policy stimulus, should economic developments warrant such action. Nonetheless, given the FOMCs forecast for a rebound in economic activity in the second half of the year, most market participants view the policy stance of the Fed as neutral neither pointing toward an imminent tightening nor easing."