The downgrade of America's credit-worthiness may in some ways be overdue. But is Standard & Poor's rating cut legitimate?
[S&P] described the decision as a judgment about the nation’s leaders, writing that “the gulf between the political parties” had reduced its confidence in the government’s ability to manage its finances.
“The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge,” the company said in a statement.
The Obama administration reacted with indignation, noting that the company had made a significant mathematical mistake in a document that it provided to the Treasury Department on Friday afternoon, overstating the federal debt by about $2 trillion.
“A judgment flawed by a $2 trillion error speaks for itself,” a Treasury spokeswoman said. ...NYT
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An error from S&P isn't that unusual. One bank economist reminded us in July that Standard & Poor's credibility has been challenged before.
There was a great little discussion about the latest statements from Moody's and S&P this morning at APM's "Marketplace." Host Jeremy Hobson spoke with Julia Coronado, chief economist with the investment bank BNP Paribas.
HOBSON: Well, do you think Julia that S&P would really follow through and downgrade the U.S.?
CORONADO: Well, S&P has sort of painted itself into a bit of a corner. It's taken a strong stance. It said that it's not about just a debt ceiling and raising the debt ceiling but about getting some longer term fiscal credibility in place. And given what's happening in Washington, that's looking less likely. Now they've given themselves a bit of wiggle room in terms of the timing, but I think it's in some sense just a matter of time before they're forced to make good on their promise and downgrade the U.S.
HOBSON: And what kind of effect would a downgrade have?
CORONADO: Well, you might think that ratings agency moves like this aren't news -- that we already know whatever S&P knows. But on the other hand, there's a lot of structures and financial markets built around these ratings. So for example, some funds that are tied to S&P ratings could be forced to liquidate their treasury portfolios if they follow through with the downgrade and that could lead to some disorderly conditions in financial markets.
HOBSON: And Julia, the S&P -- that rating agencies like S&P -- Moody's, and Fitch famously made some big mistakes with mortgage-backed securities ratings leading up to the financial crisis. Why is it that they have such credibility still?
CORONADO: Well, I think that this is a story of human frailties. This is inertia at work. While we all learned during the financial crisis that the rating agency model is basically broken, there's so much built around it -- so many structures, just the way we do business is built around these ratings that we just didn't move away from it even despite the crisis. And so here we are again with another uncomfortable situation that could end up biting us a little bit.
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The timing of the S&P downgrade, not to mention the ill-formed policies of the Republican radicals, couldn't be worse. This is a moment when even conservative economists believe government spending should prime the pump that provides jobs. Political economist Clive Crook wrote the other day:
A signal that may have helped Wall Street to tank today was Jean-Claude Trichet's interview with Dow Jones. Inflation risks have not abated in Europe, he said. Yes, he is still worried mainly about inflation. He wouldn't rule out more rises in interest rates, even alongside new measures to provide emergency liquidity.
"I exclude nothing," Mr. Trichet said. "The separation principle is a very strong one... but we could pretty well go in various directions" in terms of standard policy measures and exceptional liquidity support.
Going in various directions, to no net effect, would seem to sum up a good deal of recent economic policy, on both sides of the Atlantic. It sounds better I suppose if you call this the separation principle.
Far from worrying about rising inflation, the Fed and the ECB need to see that the situation is deteriorating to the point where engineering a spell of higher inflation is actually the right goal. I understand the dangers. In ordinary times, I am an inflation hawk. But these are not ordinary times. Ken Rogoff puts the case well.
"Some observers regard any suggestion of even modestly elevated inflation as a form of heresy. But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years. These are times when central banks need to spend some of the credibility that they accumulate in normal times."
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Daniel Indiviglio, who also writes about "the intersection" of economics, finance, and politics, anticipated S&P's downgrade.
I asked S&P about the U.S. back in May, comparing it to 2001 Japan. One of their analysts provided numerous reasons for why the U.S. debt today shouldn't be judged as harshly as Japan's debt was then. They included:
* The U.S. has better fiscal indicators, both on the stocks and on the flows.
* The dollar remains the key international currency, while the yen is a distant third.
* U.S. prices are more stable, while Japan flirts with deflation.
* The U.S. growth prospects are better.
* Japan has particularly troubling demographics, as its population is aging and skews towards the elderly.
Nothing on this list has changed since May, but S&P has become more gravely concerned with U.S. politics.
To the extent that blame is being placed, it lands on the inept Congress.
If you assume that Congress will remain divided after the 2012 elections and that Republicans will renew their pledge, then we could have more of these absurd near-default experiences. That's what worries the rating agency, says Indiviglio.
But S&P must be counting on more than just Republicans acting insanely enough to cause default: Democrats would have to act just as irresponsibly. After all, spending and entitlement cuts alone can easily allow the U.S. to avoid default. The agency makes this point, saying that the nation needs entitlement cuts and/or more tax revenue. S&P must assume that Democrats, like Republicans, could reach a limit of how much they'll concede and just let the U.S. economy burn on mere principle.
This goes a long way to explain why Obama has been so accomodating, to the rage of many of his supporters. He knew what was coming and preferred concession to allowing Congressional Republicans to destroy the country.
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The Economist's "Free Exchange" commentator, in an early reaction, also blames Congress but takes a more optimistic view.
Investors largely tuned out the debt-ceiling debate until its final days out of a belief based on long experience that for all the antics and rhetoric of the Tea Party, the people who actually run Capitol Hill would never compromise the country’s credit worthiness. After all, it was Mr Boehner who reminded his freshmen colleagues that on the debt ceiling they’d have to act like “adults.”
That is not what happened. As the fight dragged on, the leadership moved closer to the Tea Party, not the other way around. And they seem happy with the results. Why else would Mitch McConnell have promised on August 1st to do exactly the same the next time the debt ceiling must be raised? ...
...I never had much sympathy for the view that America’s economy was about to be eclipsed by China’s, and the main reason was our political institutions. Those checks, balances and laws provide an orderly means to change course in response to new challenges. China’s authoritarianism deprives the government of a feedback mechanism to tell it when it is meeting the needs and aspirations of its people. That makes its system intrinsically fragile.
Events of the last few weeks have forced me to reconsider. While the crash of a high-speed train highlighted many of China’s ongoing weaknesses, it also revealed, in the vigorous reporting and commentary that followed in print and online, a nascent apparatus of accountability. Conversely, America’s ostensible success in avoiding default in fact highlighted the growing dysfunction of its political institutions. If these events are portents of things to come, then the day when China displaces America as the world’s economic superpower is closer than I thought.
My more optimistic take is that the behavior of the markets and record disapproval ratings will force Congress to acknowledge the idiocy of their recent behavior and to adapt by substituting compromise for brinkmanship. Investors won't learn much new from S&P's announcement. Politicians should.
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Forget about the idiots in Congress. Forget about investments for a moment. What can ordinary people with car loans and mortgages expect?
Here's part of discussion at American Public Media's Marketplace:
Vigeland: All right, so the U.S. has had its credit rating downgraded by the S&P. I don't know, is this like us tanking our credit score as consumers? How worried should we be about this? Time to hit the panic button yet?
Moore: Sure. Well, it's not great for us. It's definitely going to be a little bit more expensive for us. If you have a mortgage, if you have a car loan, if you have a student loan -- any kind of debt -- you'll probably see the interest rate tick up a little bit.
Vigeland: And why is that?
Moore: Well what has happened with the credit score being cut is basically we're going to have to pay more in an interest rate to finance our debt as a country. And when the whole U.S. pays a higher interest rate, so does everyone in it. So if you have a mortgage, if you have a car loan, if you have a student loan, you're going to see your interest tick up. Hopefully, if everything remains rational, it won't be too much because we've seen this coming for four weeks. This isn't a big surprise. Nobody woke up this morning and realized we could be downgraded. So hopefully, it will all be in a nice, rational progression from here until we get our house in order.
Vigeland: Well, you're ascribing rational progression to a system that showed us this week that it's completely irrational. So when we look at this kind of adding to the pressures of what's happened over the last week, what is Monday going to look like? Do we have any idea what's going to happen over the next 72 hours?
Moore: We probably don't know, but what we do know is because all of this has been talked about for about four weeks now, people in the markets are completely rung out. Right?
