Capital Markets

Will the Government’s Rescue Plans Work?

Not for at least a couple of years, says Moody's, warning of a crushing financial burden from taking on enormous new debt.
Stephen TaubFebruary 9, 2009

If you think the government’s plans to turn around the economy will start having their desired effects right away, think again, according to a new report from Moody’s Investors Service.

In fact, the Obama Administration’s massive spending package, which appears to be nearing Congressional approval, and new efforts to prop up the ailing financial systems, expected to be announced soon by Treasury Secretary Timothy Geithner, will worsen the economy considerbly over the next two years, Moody’s asserts.

It stresses that the report is not a rating analysis, and that the government’s credit rating retains a stable outlook.

Rather, the report emphasizes the multiplier effect of debt. Moody’s cautions that simply adding up liabilities does not provide a sound perspective on how burdensome the government’s debt has become.

Moody’s points out that at the end of fiscal 2008, debt borrowed from creditors outside the federal government — which it calls the most relevant measure of overall debt — amounted to $5.8 trillion, which was equal to 40.8 percent of U.S. GDP. “Compared with the central government debt of other Aaa-rated countries, this is a moderate level,” notes Steven Hess, a Moody’s vice president and senior credit officer.

However, total debt held by the public is projected to rise by more than half during the coming two years, Moody’s adds, reaching $9 trillion, or 62 percent of GDP by the end of fiscal 2010. “In the meantime, most other Aaa governments will see their debt metrics deteriorate as well,” he adds.

Moody’s says the government’s ratio of debt to revenue, which is a measure of the resources available at any moment to repay the debt, is worrisome as well. At the end of fiscal 2008, that ratio was 230 percent — already quite high for a Aaa-rated country, and it’s forecasted to rise steeply to 378 percent by the end of fiscal 2010.

The burden of the debt, measured as the ratio of interest paid to the government’s revenue, is another important indicator, Moody’s points out. In fiscal-year 2009, this ratio is projected at about 9.5 percent, also a high level among Aaa-rated countries, Moody’s adds.

The Moody’s report also mentions some other pressure points. For example, Treasury purchases of Fannie Mae and Freddie Mac preferred stock, purchases of commercial under the Troubled Asset Relief Program, and possible purchases of financial firms’ toxic mortgage-backed or other securities under TARP will probably hurt the government’s financial position, too.

The proposed fiscal stimulus package also will increase gross debt, the rating agency asserts. On the other hand, it adds, the possible future disposal of assets the government acquires through its remedial programs could help reverse the upward trend in debt ratios.

Moody’s also warns that in 2010 or afterward, interest rates are almost certain to rise from their current low levels, making the government’s debt deteriorate.

“Going forward, the U.S. ratios will worsen, but Moody’s believes it is likely that those of most other Aaa-rated governments will worsen as well,” the report says.