Overview of Possible Solutions to US Debt Crisis

In the US, ongoing negations to come to an agreement regarding how to avoid defaulting on its loan obligations before the approaching August 2nd deadline seem to be making some slow progress. Here is an overview of the solutions that are currently on the table and how the major credit rating agencies are responding to the ongoing crisis.

Rating agencies

• Moody’s issued a statement on Wednesday, July 13th to announce his intention to put the U.S. bonds “on review.”

• For its part, Fitch remains confident in the ability of US lawmakers to raise the debt ceiling before August 2 and avoid a default on its public debt. Unlike other agencies, Fitch only plans to review its ratings for US Government bonds if the August 2nd deadline passes with no agreement on raising the debt ceiling.

• For Standard & Poor’s, the debt ceiling issue has two aspects: On one hand, there is the issue of raising the debt ceiling now in order to avoid defaulting and all of the consequences it would bring with it. But, on the other hand, the rating agency hopes to see US spending become more sustainable over time in order to avoid future scenarios like the present one.

Context

Both the US Congress and President Obama still have two weeks to overcome the current political impasse over national fiscal policy.

Propositions

For now, the main options that US lawmakers have on the table are as follows:

1 – “Gang of 6” Plan:  On Tuesday, July 19th, this bipartisan group proposed a fiscal consolidation plan, with budget cuts of around $3.70 trillion over the next 10 years in an attempt to find a compromise that will allow Republicans to support temporarily raising the debt ceiling to avoid a default.

The proposal calls for a new bill that cuts $500 billion in discretionary spending over 10 years, an immediate freeze of congressional pay and the sale of unused federal property, an overhaul of Social Security as well as other steps designed to lower government spending.

This plan has the support of President Obama and appears to be the most viable option.

2 – Republican Proposal: This plan proposes to implement spending cuts, a cap on discretionary spending and a constitutional obligation to balance the federal budget (termed “Cap, Cut and Balance”).
This project will be accompanied by an increase in the debt ceiling of $2.4 trillion (enough to avoid a default until the upcoming national elections in 2012). However, this proposition has a good chance of being rejected by the Senate, which is controlled by Democrats.

3 – Plan B (McConnell Plan): The goal of Senate Minority Leader Mitch McConnell’s plan is to enable  President Obama to increase the debt ceiling without a majority in Congress. The increase in the debt ceiling could also be accompanied by spending cuts. However, Obama rejected by this plan last week.

Conclusion

In order to ensure that US public pending remains sustainable over time, a credible plan should include roughly $3-4 trillion of tax savings over the next 10 years.

With figures within that range, the “Gang of 6” plan appears to be the most suitable one but it could meet opposition in the House of Representatives.

According to Natixis, if the bipartisan commission plan is rejected, no massive fiscal reform should be expected in the short term (at least, not until the 2012 elections) and it could mean that a much less ambitious agreement involving smaller budget cuts of approximately $1-2 trillion may be more likely to be implemented.

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