Economy Damaged by Debt Ceiling Debate

Comstock Images/ThinkstockNEW YORK -- The crisis over the debt ceiling may have already taken a toll on the fragile economy and jobs market

“I think it's clearly done some damage," says Ryan Avent of The Economist magazine. "During the run-up to this August 2nd deadline a lot companies that were concerned that a deal might not have been reached started stockpiling cash -- holding on to money that they could have been using to invest to hire new workers...sort of tumbled."

Worries about government debt have been a distraction at a time when the economy is weak, Avent explains. "We want companies out there doing what they can to get the economy moving and when you scare them like that with the threat of default that's obviously not what they're going to do."

The deal to extend the debt ceiling, says Avent, will end fears of a default and a potential financial crisis. "The agreement will be good for the economy in the sense that it prevents something really bad from happening. Either us default or the treasury scrambling around trying to figure out what bills they can not pay for the moment while legislators continue to negotiate. Markets were very nervous about something like that happening.

As for the future, many economists are concerned that cutting government spending while the private sector is weak could add to problems in the short term

"We really don’t need to be talking about cutting spending in the short term so much as seeing what we could o to boost the economy a little," Avent maintains.

Copyright 2011 ABC News Radio

Geithner on Debt Deal: Don't Know If We Will Avoid Downgrade

Lauren Victoria Burke/ABC NEWS(WASHINGTON) -- Is a credit rating downgrade for the United States more likely because of the way the process surrounding the debt compromise unfolded in Washington?

“I don’t know,” Treasury Secretary Timothy Geithner told ABC News in an interview set to air on Good Morning America Tuesday morning. “It’s hard to tell. I think this is a good result but a terrible process. And again…as the world watched Congress step up to the edge of the abyss it made them really wonder whether this place can work.”

Geithner called the debt deal “a good agreement” and said it benefits the economy in the “long term” because it will force Congress to make tough choices.

But what about the short term? Asked to respond to critics who say it could cost American jobs, Geithner said, “No, it will not.”

Will it create jobs for some of the 25 million Americans looking for work?  

“No, this agreement itself, on its own, doesn’t create jobs,” he said. “What it does is it avoids doing more damage in the short term, because the president refused to accept the types of deep spending cuts that many in Congress wanted, and it -- by locking in some long term savings it raises -- it improves the odds over time.”

Copyright 2011 ABC News Radio

Is Real U.S. Debt Figure $211T -- not $14.3T?

Adam Gault/Thinkstock(WASHINGTON) -- With the U.S. debt dragon slain -- at least temporarily -- legislators in Washington and money managers around the world breathed a sigh of relief Monday, after Congress, in intense weekend negotiations, seemed finally to have agreed on a solution to the $14.3 trillion debt ceiling crisis.

But is their celebration premature? What if the nation's attention had been focused all this time on the wrong number? What if U.S. debt isn't $14.3 trillion, but bigger by a factor of 14?

Bloomberg BusinessWeek, in its current cover story "Why The Current Debt Crisis is Even Worse Than You Think," argues the true measure of U.S. debt ought to be the so-called fiscal gap. That's the present value of the difference between the nation's total revenues and its total obligations. That comes to $211 trillion.

For Congress, as it tries to thread its way out of the nation's debt crisis, to be focused on the smaller number is like a driver "using a map of New York to try to drive around L.A." So says Boston University economist Laurence J. Kotlikoff. The BusinessWeek piece showcases the work of Kotlikoff and fellow economist Jerry Green of Harvard.

The two men, in an academic paper titled "On The General Relativity of Fiscal Language," make a simple point: Debt is in the eye of the beholder; you can define it any way you want. Washington's $14.3 trillion figure excludes things politicians find it inconvenient to call debt, such as the future obligations of the Social Security system. But just because those obligations aren't called debt doesn't mean they don't have to be paid. The present value of these and all other U.S. obligations make up Kotlikoff and Green's $211 trillion figure.

Even if Congress and the president could agree to run a balanced budget, making this year's deficit "officially" zero, says Kotlikoff, "the nation's true indebtedness would still rise by $4.15 trillion."

Copyright 2011 ABC News Radio

Wall Street Reaction to Debt Deal Short-Lived

ABC News(NEW YORK) -- A brief jump on Wall Street Monday morning greeted news of a last-minute deal to avert a government default.

Art Cashin, floor manager for UBS Financial Services says "it's a sigh of relief that our elected officials didn't drive the economy off a cliff."

But the Dow quickly gave up its triple digit gains, diving into negative territory.

He points out, “This rally may not have a long shelf life as we begin to go back to worrying about a stagnant economy and a tough time to impose austerity.”

Copyright 2011 ABC News Radio

Will U.S. Default? $4.8 Billion Investment Says Yes

Comstock Images/Thinkstock(WASHINGTON) -- Investors are spending $4.8 billion to hedge against the possibility that credit rating agencies will downgrade U.S. debt -- or worse, that the U.S. actually will default. Doomsayers predict these and other dire consequences if Congress fails to act by August 2 to raise the nation's debt ceiling.

Rating agency Standard & Poor's earlier in July warned the U.S. that it risks a downgrade of its top AAA rating to AA status, unless Congress lifts the $14.3 trillion ceiling and reduces total debt by $4 trillion over 10 years. In April, the agency lowered its rating outlook for the U.S. from "stable" to "negative."

Investors worried at the prospect of a U.S. downgrade or default could protect themselves several ways, say experts. Joe Magyer, senior analyst at the financial website Motley Fool, says an investor could go entirely to cash. Otis C. Casey, director of credit research for Markit, a financial information services company, says an investor could unload any U.S. debt he might own and move into some other safe-haven asset, such as gold, the price of which has recently hit record highs on fears over the debt fight.

A person also could invest in a mutual fund, the return for which goes up when U.S. treasuries go down. Such funds allow investors to bet against U.S. debt.

Big institutions and the most sophisticated investors use credit-default swaps (CDS), which act like insurance policies against the deterioration of debt, be it corporate or the debt of a sovereign nation. If the debt is downgraded or if the borrower defaults, a swap makes the debt-holder whole again.
The amount of money in U.S. credit-default swaps increased 57 percent this year to $4.8 billion, according to the Depository Trust & Clearing Corp, which provides clearing, settlement and information services.

Any increase in the price of a swap is a sign of investors' declining confidence in the soundness of the underlying debt. Casey, for that reason, calls swaps early warning indicators. As Congress has continued to wrestle over raising the debt ceiling, the price of U.S. swaps has risen.
Suppose that August 2 arrives, and that Congress fails to act. What happens then to holders of U.S. debt?

"Some people have speculated," says Casey, "that there are so few safe havens for investors that U.S. bonds might actually benefit if the debt ceiling isn't raised." Panicky investors, in other words, might flock to U.S. treasuries as their least-bad option. "That," says Casey, "would be the ultimate irony.”

Copyright 2011 ABC News Radio

Debt Crisis Survival Guide for Investors

Comstock/Thinkstock(WASHINGTON) -- As the Treasury Department's Aug. 2 deadline to raise the debt ceiling draws near, the fear is that if a deal is not struck in the next few days, the U.S. could default on its debt.

But even if a compromise is reached, many analysts believe that credit agencies could still downgrade the country's AAA rating.

A short-term solution would likely result in a downgrade, according to Citibank, which warned its customers that "the kick the can down the road path ... would not impress the ratings agencies."

If a downgrade occurs, it could cost more to borrow, and there could be a negative effect on the markets.  Analysts forecast up to a 10 percent drop in the stock market as a result of a downgrade.

How does this translate?  An average 401(k) of $140,000 would lose $9,000.  Mortgage rates would likely rise at least a half point.  The average home loan of $172,000 would see a hike of $19,000.

ABC News spoke with four financial experts, and here are their recommendations on how to survive the debt crisis:

What advice do you have for investors?

"Investors should stay the course and not let their emotions get the better of them.  Keep saving, pouring money into your IRAs and 401(k)s, and stay invested in stocks.  Invest for the long-term, not the next week," said Joe Magyer, senior analyst at the Motley Fool.

"You have to give some emphasis for being prepared for difficulty.  That means diversification.  You shouldn't bet heavily on one scenario.  Don't invest heavily in situations where it's a coin toss of win or loss, big winner or big loser.  Rather, invest in things that will do OK in a variety of scenarios," said Howard Marks, chairman of Oaktree Capital Management.  "Invest in companies that are not highly cyclical or highly levered.  Food/beverage/drugs, for instance, are inherently noncyclical industries.  Auto/heavy manufacturing/paper/steel, for example, are highly cyclical industries with their fates tied to the economy."

"Nobody has a crystal ball and can predict market movements with precision.  We are encouraging investors to maintain a balanced, diversified portfolio and keep a long-term perspective," advises Vanguard, America's largest 401(k) manager.

What advice do you have for investors who can't take a 10 percent hit?

"Investors can always go to cash if they're looking to avoid taking a big hit.  And if you think you can't sustain more than a 10 percent loss with your assets, then you probably shouldn't be in anything where that can happen, namely the stock market," said Magyer.  "I think selling now is reasonable if you can't sustain more than a 10 percent loss in the market. ... I understand why some people are concerned, the threat of a downgrade let alone a default is real and the impact will be painful, but I don't think the best play is to go completely conservative. ... I do think that blue chip stocks are the best play over the long-term for patient investors, particularly for retirees. ... The last place I'd want to be right now is a lot of the high-flying IPOs that have been out, so LinkedIn, Pandora, Zillow, each of those are ridiculously priced."

"If you are a small investor, there is absolutely nothing wrong with moving to the sidelines on a short-term basis to wait till the dust settles," said Hugh Johnson, chief economist at Johnson Advisors.

"We believe that market movements should not dictate your investment strategy.  If you are nervous about the stock market and are unable to withstand a severe decline, consider selling down to your sleeping point.  In other words, adjust your stock position to a level that enables you to sleep at night, but it should be a modest (not dramatic) adjustment.  But to re-emphasize, most investors should stay the course," said Vanguard.

Copyright 2011 ABC News Radio

US Dollar Hits Three-Month Low in Asian Markets

Photos.com/Thinkstock(TOKYO) -- In a sign of growing concerns over the U.S. debt crisis, the U.S. dollar index fell to a three-month low Wednesday in Asian markets.

The dollar fell to a four-month low against the Japanese yen, while marking a record low against the Australian dollar.

A board member for the Bank of Japan said failed talks in D.C. could have serious effects on Japan's financial system.  He added that he expects the finance ministry to look at whether to intervene.

The U.S. government is projected to default unless a deal is reached before next Tuesday's deadline

Copyright 2011 ABC News Radio

Debt Default: How Soon Could the Country Recover?

Stephen Chernin/Getty Images(WASHINGTON) -- While legislators describe the potentially catastrophic effects of a U.S. default on its debt or its growing budget deficit, past examples of sovereign default show other countries can recover in shorter periods than expected.

Jamaica, the only country to default in 2010, compares "favorably" with its peer countries in terms of Gross Domestic Product (GDP) per capita and Human Development Indicators, according to credit rating agency Fitch Ratings.

The Caribbean country has a population of 2.7 million and a GDP of $13.8 billion.  The total debt of its central government as a percentage of its GDP is 107.6 percent, according to Fitch.

Sovereign default events are rare.  Since the mid 1990s, Fitch has recorded a total of eight sovereign defaults, including the Jamaican default event.  The list of sovereign defaults includes Indonesia and the Russian Federation, both in 1998; Argentina in 2001, Moldova in 2002, Uruguay in 2003, the Dominican Republic in 2005, and Ecuador in 2008.

Even more infrequent are municipal or local governments defaulting on their debt.

Guy LeBas, chief fixed income strategist with Janney Capital Markets, said Orange County, California, which defaulted in 1994 following some financial mismanagement, may be the most prominent county that has defaulted in recent history.  He said several municipalities defaulted during the Great Depression.

Eduardo Borensztein, regional economic advisor at the Southern Cone department of the Inter-American Development Bank, said there is "a lot of confusion about defaults."  He said the traditional definition of a default is when a country fails to make a payment on time or there is a change in the terms of original debt that implies a loss of value for its creditors.

"So if it can't make payment according to original terms, it's considered a default," he said.

In a paper for the International Monetary Fund, Borensztein found that from 1824 to 2004, Latin America was the region with the highest number of defaults: 126.  Africa had 63 episodes of defaults during that period.

Analyzing these cases, he found that default episodes do not have a long-term impact on credit ratings or borrowing costs.  Of course, for the United States, a default would be a different story because of the sheer size of its economy, among several other factors, Borenzstein said.

"It has the highest credit rating, so going down even one notch has big implications," he said. "U.S. debt is used as collateral for other contracts and considered pretty much risk free. I don't think anyone can have a good sense of the consequences of a default."

Richard Zeckhauser, professor of political economy at the Harvard Kennedy School, said it is also unlikely that United States will default on its debt.  He said Greece, which many credit agencies had predicted would default, at least has Germany, or other European Union countries, to possibly help "bail it out."

"We unfortunately don't have a Germany.  There's no one else to rescue us," Zeckhauser said.  "Our biggest creditor is China and I don't think they'll come to our rescue."

Copyright 2011 ABC News Radio

Beyond Debt Ceiling, Housing Market Still Greatest Threat to Financial Stability

Stockbyte/Thinkstock(WASHINGTON) -- With only one week left before the Treasury Department’s Aug. 2 debt ceiling deadline, fears of another financial meltdown are reverberating through the country. Those are the very fears the Financial Stability Oversight Council are seeking to quell.

The council, which was established under the Dodd-Frank financial reform act, released its first annual report Tuesday showcasing how the Dodd-Frank Act has already increased stability in the financial market and identifying areas that are still vulnerable to another financial crisis.

But regardless of what reforms are put in place, Treasury Secretary Timothy Geithner stressed that the number-one issue threatening financial markets right now is the debt ceiling.

“The most important thing we can do right now to safeguard financial stability is lift the cloud of default hanging over our economy,” Geithner said in a statement. “As we move forward, however, we must also work to ensure that our regulatory framework keeps pace with the evolving global financial system. This report provides key recommendations that will build on the progress we’ve made through the Dodd-Frank Act and further strengthen the resilience of the financial markets.”

Aside from quickly raising the debt ceiling, the housing market still poses the most risk to the financial system’s stability, according to the report. The council suggests further regulation of home loans, strengthening mortgage underwriting and reform in the housing finance systems to help stabilize the housing market.

“An enormous amount of progress has been made,” one senior Treasury official said. “It is now a question of perfecting, rather than starting from square one.”

The council is required by the Dodd-Frank Act to issue this annual report to Congress outlining potential emerging threats to America’s financial stability, make recommendations for promoting market discipline and detail any activity the council makes.

Copyright 2011 ABC News Radio

Gold Rises, Stocks Fall over US Debt Impasse

Medioimages/Photodisc(NEW YORK) -- Gold and the Swiss franc appeared the only winners Monday, as Washington's ongoing impasse over the U.S. debt ceiling continued to depress markets.

At midday, stock markets in the U.S., Asia and Europe were all down -- the S&P 500 by 0.47 percent, the Nikkei by 0.81 percent. Gold, however, rose 0.81 percent, and futures for the precious metal hit a new record of $1,624.30 an ounce. The Swiss franc gained 2.1 percent against the dollar.

U.S. Treasuries showed surprising resiliency, with the yield on 10-year Treasuries rising to 2.98 percent. Some observers took that as a sign that fears of financial catastrophe had been exaggerated. Guy Lebas, a fixed income strategist at Janney Montgomery Scott in Philadelphia, told Bloomberg he'd expect to see a bigger move if something "truly catastrophic" was on the horizon.

Meantime, a gridlocked U.S. capitol entered its last full week of negotiations before the Aug. 2 deadline for raising the nation's debt ceiling. Earlier in the day, Secretary of State Hillary Clinton, in Hong Kong, sought to reassure Asian nations of the U.S. economy's health, reminding them that the country has recovered from such instability in the past. Clinton predicted that a debt ceiling deal would be reached before the Aug. 2 deadline to avoid an unprecedented default.

It is feared that if an agreement is not reached, the United States could lose its triple-A credit rating.

Copyright 2011 ABC News Radio