FORTUNE -- In Friday's report downgrading U.S. sovereign debt, S&P evaluated what it considers the three most likely courses for the budget and the economy. The "base case," the one that not only led to the new AA+ rating, but keeps our long-term debt on "negative" watch, is scary enough. But the really daunting forecast is what S&P, on page 5 of the report, calls the "revised downside scenario."
The rub is that the "downside" scenario may be the most likely of the three. If not, it still has an alarmingly high probability of charting our future. And if it plays out, stand by for more downgrades.
The downside view takes as its basis the CBO's "Alternative Fiscal Scenario." Instead of assuming that tax hikes and spending cuts enshrined in law actually happen, the CBO strips them out in its alternative budget to give a far clearer picture of what's likely to happen. The Alternative Scenario projects that the AMT will get fixed so that it doesn't hit more middle class taxpayers, that payments to Medicare providers aren't chopped in double-digits, and that the Bush tax cuts of 2001 and 2003 are extended, although that prediction is far from certain.
S&P adds another assumption: That the $1.5 trillion in savings assigned to the Congressional Joint Select Committee don't happen. That may be overly pessimistic, but $1.5 trillion against numbers of the scale the downside scenario lays out is relatively unimportant.
The S&P then makes two adjustments to the CBO's Alternative budget. First, it forecasts that GDP will grow at 2.5% through 2020, rather than the 3% average in the CBO forecast that matches the historical trend. Indeed, the sharp downward GDP revisions for the first half of 2011 make it far more likely we're in for a period of slogging, below-average growth.
Second, S&P forecasts that future interest rates will be significantly higher than the CBO assumes -- which makes a gigantic difference when debt reaches mountainous levels. The CBO reckons that 10-year rates will gradually rise to 5.5% by 2015. But S&P thinks rates could easily be 0.75 points higher, or 6.25%. That reflects a far higher "real" rate as the government competes with corporations for a small pool of savings, a phenomenon called "crowding out" that the CBO doesn't seriously consider.
S&P doesn't spell out the annual numbers for its scenarios. But using the CBO's Alternative baseline, we can get a pretty good look at what happens if S&P's negative, but far from unlikely, outcome actually materializes. By 2020, debt-to-GDP would reach around 100%, or $21 trillion. By Fortune's estimate, the average rate on that debt under the S&P scenario would be around 5%--remember, not all debt would be refinanced at the higher rates by that point.
Hence, the interest of the debt would total around $1 trillion, over 5 times today's number. That's 19% of all spending and 27% of all revenues. Interest then rivals Social Security and Medicare as America's biggest expense.
If the downside scenario happens, S&P states that it's "consistent with a further downgrade to 'AA' long-term." How bad is that? Once mighty America would find itself in the same category a symbol of excess occupies today, one of Europe's notorious PIIGS: Spain.
Shawn Tully has been writing feature stories for Fortune since 1980. He's covered stories as varied as the Vatican's finances, the exile of fugitive commodities trader Marc Rich, and the disastrous merger between Guidant and Boston Scientific. He specializes in banking, federal budget and spending issues, and health care. Tully holds a B.A. in English from Princeton University, an M.B.A. from the University of Chicago, and a master's in Applied Economics from the Universite Catholique de Louvain in Belgium.
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