After much whispered fanfare and anticipation, credit rating agency Standard & Poor’s lowered the U.S. government’s credit rating on Friday. Although it will require some adjustments by certain parts of the financial sector, those adjustments don’t seem likely to cause much pain, and this should be a trivial event for the most part. (“Tragic” in the title of this post refers to the misguided political actions that a downgrade is likely to spur.)
The truly amazing part is that S&P’s report had a $2T error in it that had to be caught and corrected by Treasury officials. Better yet, S&P has reportedly maintained the downgrade despite that. I get the political risks cited in the report, and the Tea Party faction of the GOP does seem hell-bent (with good intentions, I continue to believe) on forcing policy in one direction or another that could eventually result in a voluntary default on treasury debt (and other obligations well before that), but this is still ridiculous.
From S&P’s report (our comments in bold brackets):
· We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating. [Bully! Courage and integrity!]
· We have also removed both the short- and long-term ratings from CreditWatch negative. [Hey, a silver lining!]
· The downgrade reflects our opinion [seems like a key word choice] that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics. [Because clearly, the USG's mid-term debt dynamics are a mess, with markets screaming that they can't get enough of the stuff.]
· More broadly, 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 challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. [Sure, that part is true. But it's fueled to a significant degree by the lousy economic models S&P and others use. And a downgrade is like giving the fools a live grenade that they can toss back and forth at each other as they fight to see who can screw us all the best. I mean worst.]
· Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon. [The agreement, as nasty as the process was, imposed a Damoclean endgame that should have you and your rotten ilk soiling your trousers (in a good way, I mean). Enough people are sufficiently threatened by this agreement that you ought to give more credit to the politicians. And take some for yourself too. You're playing a major role in making the world a "better" place. As in less crowded, for example.]
· The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case. [Ah, yes, best to close with a scary tale that we can repeat around campfires everywhere. As I said, we're already sufficiently screwed. But to get a gold star from S&P, you have to do a lot better than that, apparently.]
It’s simply astounding that major institutions worldwide still use models far removed from reality to mess up the lives and well-being of countless people (and, Tea Partiers take note, the lives of our children and grandchildren!). That one of the main culprits in the subprime debacle (and let’s not forget Enron et al or the eurozone) is the first belle to this ball is particularly infuriating.
There’s a country called Japan that most people have heard of. That surely includes the folks at S&P, because every time they have up- or down-graded Japan’s government debt, markets have voted resoundingly that their sovereign debt opinions (hey, that’s their word!) don’t count for anything. Zero. Nada. Zip. Nothing.
Ever try pounding sand, S&P? Sounds like great exercise. Certainly better for you than typing. And better for the world if you chose it as your new line of work.
Looking for a competitive advantage, Fitch or Moody’s? Try macro models that actually capture how sovereign fiscal and monetary operations work. Start with the realization that (a) today, sovereign fiscal (and limited or occasional central bank) operations are to our global financial economy what gold mine output was in the second half of the 19th century, and (b) no one ever believed in an intertemporal budget constraint on gold mine output. The rest should fall into place pretty easily.
2011.08.08 – A scandalous accusation was hurled at S&P by a Chicago Mercantile Exchnage trader interviewed on CNBC this morning (it unfolds from 0:45 seconds to about 4:15). The gumshoe detective’s theory is that S&P’s parent, McGraw Hill, is strategically focused on expanding its rating business in Europe, as stated in its late July conference call, and that nothing will buy you credibility in Europe like downgrading the U.S.! At about 3:00, a guest affirms by observing that the European Union’s threat to start its own rating agency is an existential threat to the rating businesses. There are enough questions around S&P’s downgrade to make this a compelling thesis. Congressional investigations to follow??
Note too that several parties in the segment talk erroneously about “printing” and “monetizing the debt”. We have a long way to go before we get our paradigms in order, as opposed to our fiscal house. Treasury debt is simply another form of government liability, purchased with money that was previously created by Treasury spending. So technically, it can’t possibly be monetized, unless the Fed is simply adding an equivalent amount of dollars to the banking system and accepting nothing in return, i.e., leaving the debt out there as well (which would throw its interest rate targeting operations off in a big way, and force them to reverse the process rather quickly). So under the prevailing but flawed paradigm, the return of principal at maturity or any time before is “monetization” of debt. Does that make any sense at all??? Hint: The answer’s no, which makes us wonder just how long the gold euphoria can last. Of course, we’ve been wondering that for about the last 36%!
As noted above, S&P continues to come in for some rough treatment following their announcement. Warren Buffet and Wilbur Ross have weighed in from the billionaires’ club seats. And it seems like it could get plenty worse for S&P if the latest rumors gain traction. But there are a few folks in their camp, including Kenneth Rogoff, who helped to inspire the austerity craze, and the PIMCO boys, most notably Bill Gross and Neel Kashkari. It’s especially amusing to hear Gross, who can’t stop whining about so-called financial repression, say that it’s he and S&P who are wearing the “white hats.” He really seems to have gone off the rails. Makes me feel bad for Tony Crescenzi; happy for Paul McCulley though, who left the firm this year and has regrown his old Kristofferson-esque hippie mane. Maybe PIMCO’s clients aren’t big fans of low real interest rates or long hair?
Finally, in a column that is at once mathematically and historically entertaining and woefully bereft of any meaningful analysis, CNBC’s Rick Santelli predicts that we may be in for a fifty-four year bear market in interest rates. He gives a good, concise treatment of “Fibonacci sequences,” but it quickly degenerates into a case of really, really flimsy affirmation bias. Like all human beings, Rick sees, thinks, says, and writes what he needs to hear—”get the fiscal house in order”—when just a cursory look at the evidence should be enough to blow that argument out of the water. Probably tough to back track when you’re the spiritual founder of the Tea Party, though.
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