Wednesday, July 27, 2011

An Interview with S&P's Global Head of Sovereign Ratings

Last night, I spoke with David Beers, head of S&P's sovereign debt rating committee on CNBC’s Kudlow Report. He made it very clear: the U.S. must take steps to lower its debt/GDP trend over the long run. He is looking at all the plans, and he is waiting for a final product. But right now a U.S. downgrade is 50-50. S&P's next step could come very soon.

The video and transcript follow below.


On July 14th, Standard & Poor's placed the US on credit watch negative on the
rising risk of a policy stalemate. That clock continues to tick, August 2nd,
less than a week from tonight. How real is the US debt downgrade threat?
What will come of us? Here now for an exclusive interview is David Beers.
He's the global head of sovereign ratings at S&P, Standard & Poor's.

David, welcome to the show. I appreciate it very much. If I'm not mistaken,
on July 21 you issued a warning there's a 50 percent chance of downgrade.
Where are you tonight? Where are you today?

Mr. DAVID BEERS: Well, we're still at 50 percent, at least a 50 percent
possibility of a downgrade.

KUDLOW: All right. I want to ask you, what will it take to avoid a
downgrade? What are your guidelines telling you? What are you looking for?

Mr. BEERS: Well, given the continuing political gridlock, I guess what we're
looking for is some program which we think will make a difference over the
medium term in slowing the, if not reversing, the rising trajectory of
government debt as, for example, as a percent of GDP.

KUDLOW: And United States is around 70 percent. I believe the Congressional
Budget Office has us running up to 90 or 100 percent. You like to use total
government debt. So you want to see that instead of going up, you want to see
it ramping down. Is that fair?

Mr. BEERS: Yeah. Or at least stabilizing, with the prospect of it falling
over the medium to longer term.

KUDLOW: All right. I want to ask a couple of questions. I appreciate that
you don't want to speak specifically about the political plans. Really, when
you take the three plans that are on the table, more or less, they're running
about $3 trillion in lower deficits. I mean, they've got pluses and minuses.

Mr. BEERS: Mm-hmm.

KUDLOW: And I don't want to get into that. Is a $3 trillion reduction over
10 years, would that meet your criteria to avoid a downgrade?

Mr. BEERS: Well, to be honest, we can't answer that question tonight. I
think what we've said is we'll look at the deal, whatever the deal is, when
it's agreed by Congress and the administration, and we will measure it on a
number of parameters. One is, is it actionable? Is it actually likely to be
implemented and, therefore, is it credible? And credibility, among other
things, means to us that there has to be some buy-in across the political
divide, across both parties, because politics can and will change...

KUDLOW: Yes, sir.

Mr. BEERS: ...going forward. And if there's ownership by both sides of the
program, then that would give us more confidence.

KUDLOW: But you don't want to commit to a ballpark number?

Mr. BEERS: No. Because it's not just about the number. It's about the
all-in intent.

KUDLOW: But if it was low--if it as low as $1 1/2 trillion, would that be,
you know, downgrade city?

Mr. BEERS: It depends on what's folded into the deal. It depends on what
comes along with that number. As you know, there are lots of ideas out there
about doing this incrementally. But, ultimately, we've got to look at the
overall plan to make a judgment as to whether it's likely to make a difference
in terms of the rising tide of US debt.

KUDLOW: All right, the rising tide of US debt. Two of the three plans have a
special joint congressional committee which is supposed to find additional
spending and debt reduction cuts down the road. Now, does the down the road
part trouble you? Is that a plus or a minus in the debt--in the downgrade

Mr. BEERS: Well, naturally it's going to raise questions. And, again, we
would have to look at the balance of incentives and disincentives that might
increase or decrease the probability of that type of approach being effective.

KUDLOW: Does it matter to you if the debt ceiling is raised in one or two
tranches? In other words, if they raise, let's say for argument sake, half
this year and the rest next year. How does that affect your thinking?

Mr. BEERS: Well, we'll look at it. But we've also said on the 14th of July
that we would be concerned if we thought that the debt ceiling debate would
come back and be open and we'd have to go through all this again and again and

KUDLOW: And that would be a negative in your view.

Mr. BEERS: That would be a negative in our view.

KUDLOW: Right. That's what I thought.

All right, let me ask you this, the last scenario. The business about revenue
allocation. If we go through August 2nd, we've got some big Treasury
redemptions and interest expenses coming, 50, 60, $70 billion in August alone.
What happens in your view if that's where the US government goes? Is that a
downgrade situation? Or worse, is that a default situation? If we're
parceling revenues, let's say to pay the interest on the debt, and a little
bit to Social Security, a little bit to health care, and then half the budget
is not funded. How does that affect your thinking?

Mr. BEERS: Well, first of all, we're rating debt. Right? So it's
theoretically possible that for some period of time the government could take
that strategy while the negotiations continue. But it's worth remembering
what that would mean. It would mean a very sudden fiscal shock that the
longer it lasted would filter powerfully through the system because the US has
got--running a budget deficit right now of roughly 10 percent of GDP.
Suddenly, for a period of time, you'd essentially be running a cash surplus to
pay off the debt as it matures. So potentially that would be deeply
disruptive to the economy.

KUDLOW: Would it be default?

Mr. BEERS: No, it would not be default so long as the government is

KUDLOW: Is covering...

Mr. BEERS: pay its debt as it matures and its interest payments. But
we would suspect that that's not a tenable situation for very long.

KUDLOW: So it sounds like that would signal a downgrade.

Mr. BEERS: Well, we'll deal with that as and when the time comes.

KUDLOW: When do you reckon you'll make your next decision? Is it imminent,
this week, next week, a month from now, six months from now?

Mr. BEERS: Well, it kind of depends on what happens over the coming days.
But, you know, we had said that we'll be very--looking very closely as we
approach the 2nd of August to see if there's a deal or not.

KUDLOW: You heard the two senators. All right? They're both prominent
senators. There's nothing happening in Washington tonight. Nothing I can
report that's any good. In fact, one plan's gone back to the drawing board.
It's hard to know what the second plan is. The third plan's buried in the
White House. They admit they don't even have a plan. We're getting pretty
close it, aren't we? Downgrade is imminent?

Mr. BEERS: I'm not going to say that a downgrade is imminent. We knew that
this was going to come close to the wire, and it is, as you say. There's
still every possibility that they're going to get--come up with a plan. And
we'll--when they do...


Mr. BEERS: ...we'll look at it and we'll make a judgment then.

KUDLOW: You published a paper where you had several scenarios, and I want to
ask you about the middle scenario. What would the downgrade scenario do to
the economy and interest rates, based on your work?

Mr. BEERS: OK. Well, there's obviously some uncertainty around this because
it hasn't happened before. We sketched out a scenario, which I think is sort
of common ground in the marketplace right now, where it's possible if the
rating went into the AA category for example, the yield on government
securities could rise anywhere between, you know, 25 and 50 basis points.


Mr. BEERS: Yeah. That, of course, would filter through to other interest
rate sensitive kinds of debt, like mortgages, for example. So it would mean,
you know, that holders of mortgages, over time, as this filtered through,
would have to pay a higher mortgage rates.

KUDLOW: Fannie, Freddie?

Mr. BEERS: Yeah.

KUDLOW: Insurance companies?

Mr. BEERS: Yep.

KUDLOW: Overnight bank lending? What--can our economy take--let's say in the
short end.

Mr. BEERS: Mm-hmm.

KUDLOW: We have the best rating A-1 plus right now.

Mr. BEERS: Mm-hmm.

KUDLOW: If you notch that down to A-1 and rates jumped up 50 basis points,
how damaging you reckon that would be to our economy?

Mr. BEERS: Well, it would--it would have an impact. It would--it would have
an impact. And it would be negative. It would be a depressing effect on
economic output, on economic growth.

KUDLOW: Let me ask you one final one in the remaining seconds we have. I
know you're very active in the European ratings and so forth. Greece, have we
seen the last of the Greece crisis? You've rated them CCC. There is stuff
below that. Do you think that will be challenged?

Mr. BEERS: Well, the rating has a negative outlook, so we're pretty certain
it's going to go lower because, of course, an actual debt restructuring is now
on the table. But we've also expressed the opinion before that we think that
any near term restructuring is probably not the end of the story. There may
be another bigger restructuring down the road after that.

KUDLOW: How far down the road do you reckon that would be?

Mr. BEERS: Well, that's partly in the hands of Greek politics, but it
certainly wouldn't surprise us if a second restructuring had to be looked at
over the next couple of years.

KUDLOW: Couple of years. All right, David Beers from S&P, we really
appreciate your coming on here and talking about this...

Mr. BEERS: Thanks for having me, Larry.

KUDLOW: calmly and honestly as possible.