The US has had a free lunch for so long, thanks to the willingness of kindly savings rich foreigners to buy our Treasuries, that the realization that there are limits to what we can have, both individually and as a nation, is hard for many to accept. We managed to have guns and butter for a short while by ballooning our debt to GDP ratio. But now that we are trying to keep the good times going, or more accurately, keep the bad times from being too bad, America is learning the hard way that it is going to have to make choices and tradeoffs. Given the divisiveness of our politics, this will be an ugly process.
The latest: bit of reality rearing its ugly head: Fannie and Freddie have the potential to cost the US its AAA. From the Wall Street Journal:
So-called GSEs enjoy implicit government guarantees and could cause the U.S. to lose its sterling triple-A rating if the government were forced to come to their rescue, Standard & Poor’s said in a report Monday….The demise of Bear Stearns Cos. and the Federal Reserve’s efforts to alleviate strains at broker dealers has captured the attention of market participants who feared the financial system itself might seize up last month.
While this credit crunch has hurt financial markets, S&P notes that it hasn’t threatened the standing of the nation’s credit quality upon which U.S. Treasurys and debt priced off this government debt depend. But should a protracted recession cause Fannie and Freddie to buckle, the U.S. rating would be in danger.
The cost to the U.S. government in such a scenario would be as much as 10% of gross domestic product. The maximum potential cost of aiding the broker dealers during a prolonged economic downturn would be below 3%, S&P analysts found. The Federal Reserve’s bailout of Bear Stearns and its extension of credit facilities to brokers so far costs less than 1% of GDP.
Freddie and Fannie’s exposure to the housing market heightens the risk of future losses should borrowers run into trouble as home prices decline. That the two companies are guaranteeing larger loans as part of the government’s efforts to shore up the housing market adds to this risk.S&P says, “These potential risks are not a prediction, but a risk worth monitoring.”
It was only in January that Moody’s warned that the US might lose its AAA rating within the next ten years. The S&P note simply provides a specific scenario.
Yves Smith 
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“Given the divisiveness of our politics, this will be an ugly process.”
I would venture to compare our politics to the politics in academia. Confy, with a full belly and secure future, our estimated professors can’t find anything better than to bitterly argue and fight with venom about their respective pet theories.
I’m not so sure it’d be that way if they had to focus on keeping their job and making sure they’ll effectively have a future.
IOW, our politics would have to get real in times of great pain. The reality-based crowd would once again, rule the land.
Now, I’d rather not speculate about the state of the land when they’d get there.