NPR reporters examined the reactions to S&P's downgrade yesterday afternoon -- including Republican candidates jumping all over President Obama, blaming him for the US losing its AAA rating. It began to look like the president is supposed to carry the full weight of the historic downgrade. And then they talked with the managing director and chairman of of Standard & Poors sovereign ratings committee, John Chambers.
Chambers: You're going to need eventually either some action on entitlements -- either by changing the parameters of the programs or raising additional revenues to pay for those programs.
NPR's response points out the obvious.
NPR: Changing the parameters of Medicare and Social Security or raising taxes. That sounds like quite a challenge for this White House. ...But it's been a challenge for President Obama since he said months ago that he wanted to do this. This was the plan that he was pushing all along during the debt ceiling talks. And it's the plan that the bipartisan "super Congressional committee" -- that's going to focus on finding more in deficit reductions -- has been looking for. Obviously Democrats are resistant to changing Medicaid, Medicare, and Social Security; Republicans are resistant to increasing tax revenues. But in some ways this S&P downgrade may give more incentive to those lawmakers to make those kinds of hard choices and make those changes.
We know already that Wall Street has been, if anything, on Obama's side. This seems to confirm that they remain on the same page.
What seems obvious from the chairman of the ratings' committee's statement is that the S&P downgrade -- while it remains a very questionable action -- is aimed at Congress rather than the president. Obama's mix of reforms and revenues hits many on the left, who are perhaps only somewhat less resistant to changing the social programs than the right are to adding taxes. But those reforms, which President Obama has insisted on despite dismay on the left, are what the "sovereign ratings committee" is looking for.
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Standard & Poors met with members of Congress just before the downgrade. The meeting left Congress angry. Other downgraded governments have had the same reaction. But this time Congress rightly pointed to S&P's failure to foresee the 2007 financial crisis. They're mad.
The tension between Congress and the ratings agencies could have tangible results on the companies’ futures if it speeds up new rules that lessen their roles in the market. As part of the financial reform bill passed last summer, regulators are supposed to write rules designed to reduce the heavy reliance on credit ratings by banks and other buyers of debt securities, a policy that has its roots in the 1930s.
Federal bank regulators have not yet created these rules and a Congressional committee held a hearing on July 27 on the slow pace of regulators’ implementation of this part of the law. Fierce debate broke out at the hearing about whether it was appropriate for the ratings agencies — companies regulated by the federal government — to be rating United States debt at all.
Good point. A lot of us have been wondering the same thing. Worse, the ratings agencies profitted from the mortgages that brought the financial system to its knees.
And then there's the fact that the other ratings agencies have not (so far) gone along with the downgrade.
Analysts at Fitch agree with Moody’s that, by various debt ratios, the United States is not out of line with other AAA-rated countries — putting the two at odds with S.& P. But Fitch’s top sovereign analyst said it would be monitoring the ability of lawmakers to agree on $1.5 trillion in further cuts and, if they can’t, it will look to see if Congress follows the triggers for automatic cuts it put in place last week.
“We’ve had similar triggers in place under previous budget acts and sometimes they’re allowed to operate and sometimes not,” said Mr. Riley , of Fitch.
He acknowledged there was a perception in the markets that a country is not a true AAA if all three major agencies do not agree.
“In that respect, S.& P.’s action has already weakened the U.S.’ profile,” Mr. Riley added.
So now, if S&P are persuaded they've been a bit hasty with the downgrade, the damage is already done. Nice.
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More evidence that the ratings downgrade and the general kerfuffle about the deficit is unjustified comes from Paul Krugman. He has made a solid case for the fact that "the size of the deficit in the next year or two hardly matters for the US fiscal position — and in fact the size over the next decade is barely significant."
Start with interest rates. What matters for debt sustainability is the real interest rate, since what matters is keeping real debt, not nominal debt, from growing. (World War II debt never got paid off, it just eroded in real terms to the point where it was trivial). As of yesterday, the US government could lock in 30-year bonds at a real interest rate of 1.25%. That means that a trillion dollars in extra debt would mean $12.5 billion a year in additional real interest payments.
Meanwhile, the CBO estimates potential real GDP in 2021 at about $18 trillion in 2005 dollars, or around $19 trillion in 2011 dollars.
Put these together, and they say that an extra trillion in borrowing adds something like 0.07% of GDP in future debt service costs. Yes, that zero belongs there. The $4 trillion S&P said it needed to see clocks in at less than 0.3% of GDP.
These are not, to say the least, make or break numbers.
In other words, over time we have to bring spending in line with income and lower the deficit. But "S&P (and others) obsess about those medium-term numbers, without ever explaining why."
Maybe they think there’s some critical level of debt — but they don’t know that. Maybe they think that fiscal austerity over the next decade will somehow guarantee good behavior further out — but that didn’t work in the 1990s. Or maybe they’re just pulling stuff out of regions I can’t mention in the Times.
The point is that while S&P may try to give the impression that it’s just doing the math (incompetently, too!), the math doesn’t at all support its position.
Which is what bothers me and a lot of other people. If we look at the political yammering going on, we're transfixed by the extent to which this "crisis" was, is, and apparently will continue to be a fantasy concocted for use as a political tool.
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James Kwak at Simon Johnson's "Baseline Scenario" is having the same reaction.
I think the whole thing is preposterous. S&P downgrading the United States is like Consumer Reports downgrading Coca-Cola. Consumer Reports is a great institution. For example, if you want to know how reliable a 2007 Ford Explorer is going to be, they have done more research than anyone to figure out the reliability history of every single vehicle. Those ratings are a real public service, since they add information to the world. But when it comes to Coke and Pepsi, everyone has an opinion already, and no one cares which one, according to Consumer Reports, “really” tastes better. When S&P rated some tranche of a CDO AAA back in 2006, it meant that some poor analyst had run some model fed to her by an investment bank and made sure that the rows and columns added up correctly, and the default probability percentage at the end was below some threshold. It might have been crappy information, but it was new information. When S&P rates long-term Treasuries AA+, it means . . . nothing. And if any serious buy-side investor were tempted to take S&P’s rating into account, she would be deterred by the fact that the analysis that produced the rating included a $2 trillion arithmetic error.
Kwak isn't just blowing smoke (or spewing Pepsi) here. Take a look at this.
When it comes to sovereign debt issued by major countries, investors already use their own judgment instead of following credit ratings. These are the current ten-year yields for fifteen countries that had AAA ratings on Friday:
- Switzerland: 1.17
- Singapore: 1.79
- Germany: 2.34
- Sweden: 2.34
- United States: 2.56
- Denmark: 2.58
- Canada: 2.63
- Norway: 2.63
- United Kingdom: 2.68
- Netherlands: 2.77
- Finland: 2.90
- Austria: 2.97
- France: 3.14
- New Zealand: 4.50
- Australia: 4.64
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Felix Salmon makes three cogent points, written just before the actual downgrade went public:
Firstly, talk of debt-to-GDP ratios and the like is a distraction. You can gussy up your downgrade rationale with as many numbers as you like, but at heart it’s a political decision, not an econometric one.
Secondly, the US does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default. The Tea Party is fully cognizant that it has been given a bazooka, and it’s just itching to pull the trigger. There’s no good reason to believe that won’t happen at some point.
Finally, it’s impossible to view any S&P downgrade without at the same time considering the highly fraught and complex relationship between the US government and the ratings agencies. ...
