CEO First Round

There is a possibility of real reform but also the possibility of increased gridlock on the political front.
Although the S&P could have waited to make the decision to downgrade our credit rating, there are justifications and S&P has explained their position very clearly. They would not accept the U.S. continuing to take on more debt to reach Italy’s level of net debt to GDP in the next 10 years. The Budget Control Act didn’t bend the cost curve significantly enough through cuts and budget adjustments.

This is a meaningful event that will have a ripple impact for decades to come. It is the most important credit action I’ve seen in my 30 years as an economist. Eventually, every credit area including your own rating will be impacted.

The debt ceiling agreement opens the possibility of real reform, or could be the continuation of unsustainable policies.
If the President and Congress reach an agreement on spending cuts and revenue increases that avoids sequestration and deals with entitlements, Moody’s may keep our rating at “AAA” and S&P could stabilize at “AA+.” An S&P  increase to “AAA” won’t happen anytime soon. We need to not only stop the debt load increase but show true reversal of the trend.  If this scenario plays out, health care payments to providers will be curtailed but benefits won’t be eliminated.

If the “super committee” fails to approve a deal or a compromise is rejected by Congress or the President, automatic sequestration kicks-in. This will result in losing our Moody’s “AAA” rating and the S&P will further downgrade us. Sequestration results in mal-distributed cuts which would have to come from discretionary budget funds. This is what the government does for us: workers, Social Security check processing, federal research grants, the EPA, energy subsidies, etc. Mandatory spending would be walled off—food stamps, Medicare, Social Security, etc.—but Medicaid would be cut by two percent.

The deal improves the debt-to-GDP trajectory, but with few immediate cuts, much of the implementation is left for future congresses.
The actual FY budget cuts kick in with $900 billion to deal with including NIH funding which picks up momentum in ’13 and ’14.

By walling off entitlements, discretionary spending will be hard hit (especially if the automatic sequester kicks in).
If the “super committee” can’t reach consensus which it may not with its makeup of “super liberals” and “super conservatives,” sequestration will further affect discretionary cuts.  Health and Human Services would be greatly reduced which in turn would have some impact on every American. If the Defense budget is threatened push back on sequestration might lead the committee to look at revenue increasing measures including limiting tax deductions.

Defense spending is the other prime area targeted for savings. However, health care spending will be the major driver of spending growth. Health care costs are the single biggest issue dwarfing the costs of Social Security. Calculations show the majority of increases in Medicare and Medicaid—mainly in rising nursing home cost projections.

Revenue increases are also needed, but solely taxing the rich is insufficient.
To bend the curve back and reinstate the triple rating, a Pew analysis shows a multi-pronged approach is needed to reduce debt. The required permanent spending cut and tax hike would be about 12 percent beginning in 2016.

The S&P downgrade drew headlines, but broad underlying economic weakness caused the significant fall in rates and equities.
We’ve only seen the market gain and lose these percentages in the same day seven times over history. However, we’ve received recent good news on unemployment rates and decreased energy prices. Consumer confidence is shaken and if stock prices continue to drop and stay declined, higher income consumers won’t spend.

Tax-exempt rates follow UST yields lower over the week; volatility is expected to continue on the back of S&P downgrade of the U.S.

Municipal bond funds experienced heavy outflows of $232 million last week.

Tax-exempt rates are below historical averages.
They are at the lowest rate in 20 years. It is a good time for a high-rate borrower to fund projects.

Although forecasting is difficult, interest rates are generally expected to increase in 2011.

Q&A
Q:  Forecasts might indicate a recession. Are we in one?

A: No, I don’t think so. Our jobless claim numbers have improved which belies a recession. At J.P. Morgan, we estimated odds of another recession as three-to-one. However, there is concern about Europe—they could be sliding toward a recession.

Q: If Defense spending is cut, won’t that have a significant impact on unemployment?

A: Yes, it could keep us from a further reducing unemployment or even raise the numbers. Sequestration would have a huge impact. States affected would have to make other cuts. Maryland, Missouri, Connecticut and other states with large procurements along with the Sunbelt states with most of the military bases would be hardest hit.

Q: What are your thoughts about the makeup of the “super committee?”

A: On a simple macro level, the members reflect the current divisive ideology in D.C. However, there might be members willing to compromise. Republican members Rob Portman of Ohio and Pat Toomey of Pennsylvania seem to be reasonable.

Even the best outcome by the “super committee” won’t end with the best solution. The best case scenario has to address an increase in revenue and reduction of tax deductions, maybe even those for non-profits. This would have a direct impact on your endowments and fund-raising ability.

Q: Is there a call-to-action or do you have advice for our children’s hospitals?

A: 1.) It is a free-for-all in D.C. right now and will be for the rest of the year, not just with the “super committee” but with specific areas of reduction. NIH will be hit hard. As you protect your interests, they may push back. So, you need to have a strong lobbying strategy and a presence like never before. Children’s hospitals will need to fight the Defense and the non-discretionary items to keep Medicaid payments and other funding.

2.) S&P changed the economic landscape with our downgraded rating. Rating agencies have not mentioned health care yet but they will start figuring out the context of a reduction in entitlement program payments and impact on your financial picture. You need strategies for protecting your credit ratings. As the sovereign rating is downgraded, your rating will ultimately be affected.  Children’s hospitals’ dependence on government revenue means you will be required to be more transparent in your interactions with the government and rating agencies will ask for much more information.

3). Be aware that your investments are threatened. If the volatility of the market continues and prices and values drop and won’t rally on a sustained basis, then your portfolios will be affected.

4.) Interest rates are very low—historically low. If you need to finance or refinance it is an attractive time for fixed rates.