U.S. Treasury Secretary Janet Yellen called Fitch's credit downgrade "entirely unwarranted." American Action Forum President Douglas Holtz-Eakin, who is also a former director of the Congressional Budget Office (CBO), breaks down the U.S. reaction to the downgrade while the debt issue continues to be unresolved. "This is a shoot-the-messenger operation, but the messenger is not the problem," Holtz-Eakin says, going on to say that lawmakers are "fighting about the least important things in the federal budget." Holtz-Eakin also comments on the political climate as Fitch's downgrade comes ahead of an election year.

This post was written by Luke Carberry Mogan.

Video Transcript

AKIKO FUJITA: Our top story of the day, Fitch downgrading its AAA credit rating on the US.

The agency blaming rising political divisions and mounting debt.

Treasury Secretary Janet Yellen denouncing the move, calling it, in her words, "entirely unwarranted."

Our next guest says Fitch made the right move.

Joining us now is American Action Forum President and former CBO Director Douglas Holtz-Eakin.

It's great to talk to you today.

Help me understand why you think this is warranted.

I'm also curious to hear about what you make of the timing of all this coming just months after the US narrowly avoided a debt default.

DOUGLAS HOLTZ-EAKIN: Well, on the substance, you know, Fitch said three things.

Most of the conversation has been about the erosion of governance.

But they also pointed out importantly that the US has a seriously unsustainable fiscal outlook, high deficits and debts that will get higher relative to GDP as far as the eye can see.

And importantly, it has no plan to deal with its fiscal outlook.

And so on the substance, the US has a very big problem.

And this isn't news.

This has been true for a while.

And the fact that we continue to not deal with it, I think, is at the heart of the downgrade.

The more controversial piece is this notion that there's an erosion of the capacity for governance and financial management.

And that this is, as a result, what Fitch moved now.

And there are a lot of talk about timing, but I think timing has very little to do with this.

We've had a problem for a long time.

We haven't dealt with it.

That's what needs to be dealt with, not what's going on right now.

If you look at the debt ceiling, the fight, the latest political skirmish that, you know, lots of finger-pointing about that, it's actually, I think, a really good example of the problem.

That got us a suspension of the debt ceiling until January of 2025.

Great, that's the only good news out of that deal.

Substantively, it did nothing to deal with the budget outlook, because it didn't touch taxes.

It didn't touch the entitlement programs.

And those are the problems.

It touched discretionary spending.

That's not the problem in the federal budget.

And those caps are unlikely to hold.

Congress has never adhered to its own caps.

Governance-wise, that the entire episode is being relitigated right now in the annual appropriations process.

The House and Senate are $100 billion apart, are unlikely to come to agreement.

So it didn't solve any financial management or governance issues.

So I think Fitch is reading the evidence pretty straightforwardly.

AKIKO FUJITA: So it's about how long this has been going on?

I mean, you look at Fitch's own modeling, it shows concerns with US governance dating all the way back to 2018, right?

And that's five years ago.

It showed recovery that was happening over the last year at least under this administration.

I mean, sure, maybe timing doesn't necessarily matter, but why years later after they saw this?

DOUGLAS HOLTZ-EAKIN: I think it's a very strange argument, which was made today by the CEA Chairman Jared Bernstein that, well, we should have had a downgrade under Trump.

Right, that's what we should have had and not now.

Well, why is that a good defense of what this administration has done?

I mean, it has done nothing to deal with the fundamental problem.

It has said openly, the president of the United States, in the State of the Union, we shouldn't touch Social Security, Medicare.

It is impossible to rectify the US fiscal situation without putting them on sustainable paths.

So they're actually part of the governance problem.

They're pointing in the wrong direction.

So I think this is a shoot the messenger operation.

But the messenger is not the problem.

The problem is the problem.

And it needs to be dealt with.

And it's not being dealt with.

SEANA SMITH: So there's a responsibility, right?

And I think you agree with this just on both sides of the aisle that these issues, these fiscal issues, need to be dealt with.

Do you think this downgrade from Fitch, is this really going to move the needle at all?

Is this going to push both sides to be able to come to a better longer term or a longer-term solution?

DOUGLAS HOLTZ-EAKIN: I'd like to think so.

I'm not convinced that-- it's one of three rating agencies.

If we got S&P and Moody's to join hands and downgrade as well, that would get a lot of attention that would move credit spreads, that would affect markets dramatically, and that might spur more action.

But I don't see that happening from just Fitch moving by itself,.

AKIKO FUJITA: You know, we're looking at the market reaction today, a sell-out that's not happening.

But you could argue that they has been a little complacency kicking in even among investors about what this downgrade really means when you consider what happened the last time.

And I wonder, when you think about how much debt there is right now and you look at the higher rate environment, to what extent is that risk accelerated now?

DOUGLAS HOLTZ-EAKIN: Certainly, the federal budget is now a highly-levered, interest rate-exposed entity.

You know, over the next 10 years, the US is going to spend about $80 trillion.

$10 trillion of that is going to be interest on previous borrowing.

And so when you're getting up to an 1/8 of the budget, over 12%, that's a real exposure.

And that should be a cause for concern by rating agencies and everybody.

So I hope that this rate environment and the exposure of the budget to interest rate swings will really spur some action to get things under control.

SEANA SMITH: Doug, we heard from Mohamed El-Erian.

He was on "Yahoo Finance Live" earlier today.

He was skeptical of Fitch's change.

Let's play a quick soundbite from what he had to say.

MOHAMED EL-ERIAN: So the only response I would have to this is, why now?

What Fitch put in their statement has been true for a while.

So why now?

And that explains the reaction that I and many others have had, which is, first, this is surprising.

Second, when you look at the reasoning the reason, you scratch your head as to the timing of this.

And then thirdly, which is most important for our audience, is the expectation that this will have minimal impact on the things that are sensitive to ratings.

SEANA SMITH: So Doug, we can debate the timing all we want.

But we are seeing some concern, at least right now within the equity markets.

But from your perspective, the economic implications of this, why this issue needs to be addressed, the risks that are associated with this.

What's on top of mind for you?

DOUGLAS HOLTZ-EAKIN: This is not something that is a feature of the landscape over the next six quarters, say.

You know, Fitch had in its press release that a call for a recession.

That's pretty irrelevant.

This is about the basic mismatch over the long term of spending and revenues.

And remember that every time you take $1 from private investments, put it into a government investment-- the best government investment, you lose half the rate of return.

And most of the federal budget is not about investment.

Indeed, we're increasingly squeezing that out and doing just transfer programs and consumption.

So the federal budget is the greatest headwind to productivity growth, innovation, and raising the standard of living, the single biggest threat.

So that's a self-inflicted wound that we should just stop.

Put it on a more sustainable trajectory and allow people to make more money over the long term and move ahead.

The standard of living doubles about every 70 years now.

It used to be every 35.

So it's harder and harder to reach the American dream.

And the federal budget is at the heart of those problems.

AKIKO FUJITA: So Doug, let's talk a bit more about that path ahead.

I mean, you look at where both parties are.

It seems very polarized environment in DC.

What are some of the cuts that they can agree to?

How do you reduce this number if, at the end of the day, spending is just way, you know, has gone out of control?

DOUGLAS HOLTZ-EAKIN: So the things that they are fighting about are the least important things in the federal budget, the annual spending on defense and non-defense discretionary.

What matters is Social Security.

Social Security is going to-- the trust will bankrupt in 10 years.

That means a 55-year-old does not have any idea what he or she will get in retirement.

That's a huge disservice.

That's no way to run a pension program.

On behalf of the beneficiaries, do a Social Security form that puts on a sustainable path, so that individuals can plan and the budget's not bleeding red ink.

Medicare is responsible for a third of all federal debt outstanding.

It is not designed to be financially self-sufficient.

It needs to be put on a sustainable path.

It's a core part of our social safety net.

So the discussion should be about, what will be the scale and growth of these large pieces of our social safety net?

And it's not.

It's about a red herring, this piece, which is the annual spending.

And we have to have a real conversation about the tax code.

The 2017 tax reform is going to sunset in 2025 in its entirety.

Is that something we want, don't want?

What are you going to have to-- what's it going to take to be able to afford to keep rates at this level or have them go up for everyone?

Those are conversations that we should have, not the ones we're having.

AKIKO FUJITA: You think we can have that meaningful conversation a year out from a presidential election?

DOUGLAS HOLTZ-EAKIN: No.

No, I don't.

I think the most-- to me, the most telling thing about this is the average American has no idea there's a problem.

This has gone on for the entire 21st century under Presidents Bush, Obama, Trump, and now Biden.

No one has said to the American people, we have a big problem, and we need to deal with it.

They have said other things.

You know, President Biden has continually proposed new programs that would massively expand the problem without any cause or concern.

President Trump said nothing.

President Obama said, well, there's really nothing wrong with the federal budget as long as the rich pay their fair share.

And President Bush said, well, you know, the budget is about winning the global war on terror.

So no one who holds the highest office in this land has put on the radar screen to the American public that they need to think hard about our fiscal future.

And that I think is the fundamental problem.

AKIKO FUJITA: Well, it's great to get your perspective today.

Doug Holtz-Eakin, American Action Forum President and former CBO Director, thanks so much for joining us today.