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Traders work on the floor on the New York Stock Exchange on April 18, 2011 in New York City.following news that Standard and Poor's had cut its long-term outlook on U.S. debt to negative. (Spencere Platt/Getty Images/Spencere Platt/Getty Images)
Traders work on the floor on the New York Stock Exchange on April 18, 2011 in New York City.following news that Standard and Poor's had cut its long-term outlook on U.S. debt to negative. (Spencere Platt/Getty Images/Spencere Platt/Getty Images)

Threat of U.S. credit downgrade a rebuke to political posturing Add to ...

Since Barack Obama laid his deficit reduction cards on the table in a signature speech last week, Democrats and Republicans have each sought to portray the other party as "unserious" about tackling America's fiscal mess.

On Monday, they were all told to get serious. And soon.

The unprecedented scolding from a top credit agency served to puncture the mood of optimism that followed the President's move last week to present his deficit reduction plan and call for a deal with Republicans by summer.

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The warning from Standard & Poor's that the United States faces a one-in-three chance of losing its stellar triple-A credit rating within two years underscored the bond rater's lack of faith in politicians' ability to address the debt burden in a proactive way.

The negative outlook, S&P said, reflects "increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after the national elections in 2012."

The likelihood of a breakthrough by the end of June - on reining in a debt load that is projected to exceed $20-trillion (U.S.) by 2020 - was never very high. But the suddenly real threat of a credit downgrade could put pressure on Congress to adopt major reforms at least before the 2012 vote.

While no one is suggesting the United States risks a Greece-like debt crisis any time soon, the country's continued failure to address its budgetary problems could undermine investor faith in its creditworthiness just as it struggles to emerge definitively from the worst economic downtown in decades.

Instead of feeling chastened by the S&P report, however, each party sought advantage in it. Republicans claimed it buttressed their demands that a deal on raising the federal debt ceiling include deeper spending cuts in the 2012 budget. The current $14.3-trillion limit on Treasury borrowing will be reached by mid-May.

Democrats countered that the report underscored the need for a "clean vote" on the debt ceiling, with no strings attached, so as to reassure investors that they can continue to buy U.S. Treasuries without fear of a default.

"We cannot play chicken with the full faith and credit of the United States government," White House press secretary Jay Carney said. "Regardless of …what [deficit reduction]agreements are reached along the way and in what time frame, it is absolutely a fact that Congress will raise the debt ceiling, because not to do that would be a catastrophic folly."

Indeed, a deal on raising the debt ceiling is a near certainty. But it will not come before politicians subject Americans and the world to an extravaganza of brinkmanship, just as they did leading up to the April 8 deadline for a deal on the 2011 budget. A "last minute" agreement averted a government shutdown.

Addressing S&P's concerns about the non-computation of the country's long-term fiscal math matters countless times more than the posturing over the debt ceiling.

Competing proposals from Mr. Obama and Republicans in the House of Representatives - each projecting about $4-trillion in deficit reduction over the next decade or so - temporarily sidelined the Cassandras last week. But S&P poured cold water on the optimism by calling the "path to agreement challenging because the gap between the parties remains wide."

Each side has drawn a fundamental line in the sand. For Republicans, tax increases are verboten, while the White House and most Democrats refuse to entertain entitlement reform worthy of the name. Yet, a credible plan to put the country on a sustainable fiscal track likely requires both tax increases and reform of entitlement programs, such as Medicare.

"There's nothing serious about a plan that claims to reduce the deficit by spending a trillion dollars on tax cuts for millionaires and billionaires," Mr. Obama insisted in criticizing the House Republican proposal. Mr. Obama's plan reprises his 2008 promise to roll back George W. Bush's tax cuts on households earning more than $250,000, while preserving Bush-era rates for others.

But as former Federal Reserve chairman Alan Greenspan said on Sunday, the middle-class also needs to pay more: "This crisis is so imminent and so difficult," Washington needs to let the Bush tax cuts expire for everyone.

House Republicans refuse to go there. Instead their plan calls for turning Medicare into a voucher health-care program for seniors by 2021 and providing block grants to the states for health care for their poorest residents. The plan put forward by Wisconsin congressman Paul Ryan was passed the GOP-controlled House on Friday.

The Ryan proposal would reassure markets by providing more control and certainty regarding federal health-care costs. But critics say it would come at the expense of equity, as most seniors would be required to pay more for their health care, while some states would likely slash health benefits for the poor.

Republicans "paint a vision of our future that's deeply pessimistic," Mr. Obama said. "Their vision is less about reducing the deficit than it is about changing the basic social compact in America."

With that "social compact" line, Mr. Obama staked his ground for the 2012 campaign only a week after officially declaring his candidacy for re-election. Democratic strategists want Republicans to "wear" their House vote in favour of "privatizing" Medicare, betting electors will punish the GOP for toying with a cherished social program.

Still, the White House and the Democrats must weigh the risks of stalling on adopting major spending reforms in the face of rising anxiety over the federal debt among voters and investors alike.

"My best guess is that there will be some progress before the election - enough that they can say 'we did something,' " offered University of Oregon economics professor Mark Thoma. "But I don't think it will be enough to solve the problem. There will some residual left after 2012."

Editor's Note: Due to an editing error, the newspaper and on-line versions of this story made it unclear who was proposing to roll back the Bush tax cuts. The roll back is part of Mr. Obama's plan, and this story has been changed to reflect that.

Follow on Twitter: @konradyakabuski

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