In a famous exchange from Ernest Hemingway’s The Sun Also Rises, one friend asks “how did you go bankrupt?” to which the friend replies, “two ways, gradually and then suddenly.”
During a “fireside chat” hosted by my firm on May 1 in Columbus, former Indiana governor and Purdue University president Mitch Daniels was asked about one policy issue he strongly believes isn’t getting enough attention today.
Mitch responded, “the national debt we are about to dump on people who deserve better. It has been a sad failure of our democracy. It will be a black mark on the way my generation and generations adjacent to it are remembered. This is not the way The Washington Post and some of these people talk about democracy dying. This is how they die. They spend themselves broke.”
Daniels’ comments proved prescient when just 15 days later Moody’s Investors Service (Moody’s) downgraded its credit rating on U.S. government debt, saying “successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration. Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government’s debt and interest burden higher.”
A credit rating is used to predict whether a borrower will repay its debts, on time and in full. Whether you’re an individual, company or a sovereign nation, a strong credit rating is treasure that must be guarded zealously. Your creditworthiness determines both your access to credit and the cost. From a lender’s point of view, the very best outcome is the borrower makes all of its scheduled payments, in full and on time. In other words, while there is no upside from “on time and in full,” there is a whole lot of downside.
The “riskier” you are considered as a borrower, the higher the interest rate a lender will demand to compensate for assuming your risk.
Not surprisingly, Treasury Secretary Scott Bessent dismissed Moody’s one notch credit rating downgrade of U.S. government debt from its strongest Aaa to Aa1 as irrelevant, saying “Moody’s is a lagging indicator—that’s what everyone thinks of credit agencies.” What else is he going to say?
Moody’s, S&P Global Ratings (S&P) and Fitch Ratings (Fitch) are the three primary credit rating agencies (CRAs) for corporate and government borrowers. Moody’s was actually the last CRA to strip the U.S. of its highest credit rating.
On Aug. 1, 2023 Fitch downgraded its rating for the U.S. from AAA to AA+, saying its decision “reflects the expected fiscal deterioration over the next three years, a high and growing government debt burden and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”
On Aug. 5, 2011, S&P cut its rating for the U.S. from AAA to AA+ (where it remains) following a debt ceiling standoff, stating “the effectiveness, stability and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” Sound familiar?
Then, as now, government officials and most investors shrugged-off the credit ratings downgrades as meaningless. It’s true the U.S. government borrows in dollars and owns a printing press, so theoretically can never default on interest/principal payments (aside from periodic, self-inflicted “debt ceiling” crises, a related but separate can of worms).
I asked Mitch if he thought the Moody’s downgrade was a non-event. He said, “the latest downgrade doesn’t tell us anything new; Indiana has had a better credit rating than the federal government for a dozen years. But it’s urgent that Americans face the brute fact that we cannot afford all the government we now have, and are on track to break the promises of our safety net programs, an unacceptable default of our responsibility. Maybe this slap in our national face will help bring closer that essential awakening.”
At the end of the day, it’s not the credit rating that matters, but the confidence of lenders the U.S. will honor its repayment commitments, come hell or high water. This confidence is a fragile piece of fabric held together by gossamer-thin threads of trust, which are being tugged apart both by our lawmakers’ lack of discipline and political will to address our chronic and worsening fiscal situation and more recent events like starting tariff/trade wars against our allies.
John Pierpont (“J.P.”) Morgan was the world’s most powerful financier a century ago. During Congressional testimony, Morgan was asked if commercial credit was based primarily on money or property. Morgan’s famous reply was, “No sir, the first thing is character. Before money or property or anything else. Money cannot buy it…because a man I do not trust could not get money from me for all the bonds in Christendom.”
This is sage and timeless advice investors and lawmakers should heed.
Mickey Kim is the chief operating officer and chief compliance officer for Columbus-based investment adviser Kirr Marbach & Co. Kim also writes for the Indianapolis Business Journal. He can be reached at 812-376-9444 or mickey@kirrmar.com.
