Monday, August 8, 2011

Downgrade

As everyone is no doubt aware by now, on Friday, Standard & Poor’s downgraded the United States from AAA to AA+. As I’m not an economist, I’m not going to try to discuss the ramifications of this downgrade. But I do want to talk about several aspects of how the downgrade was determined, reported, and received.

First, it is worth remembering that Standard & Poor’s also gave AAA credit ratings to investments based on sub-prime mortgages prior to the 2008 economic crisis. How well did that work out? Second, Standard & Poor’s has apparently admitted that it made a slight error in the calculations that led to the downgrade. How slight? Only about $2,000,000,000,000 (yes, that’s $2 trillion). For more details on this little error, please read “Chart of the Day: S&P’s $2 Trillion Error Explained”.

I also want to look at how news of the downgrade has been presented. Here is the entire AP article published by The Indianapolis Star on Saturday, August 6, 2011 (emphasis added):*

The United States has lost its coveted top AAA credit rating.

Credit rating agency Standard & Poor's on Friday downgraded the nation's rating for the first time since the U.S. won the top ranking in 1917. The move came after Congress haggled over budget cuts and the nation's borrowing limit — and failed to cut enough government spending to satisfy S&P.

The drop in the rating by one notch to AA-plus was expected. The three main credit agencies, which also include Moody's Investor Service and Fitch, had warned during the budget fight that if Congress did not cut spending far enough, the country faced a downgrade. Moody's said Friday it was keeping its AAA rating on the nation's debt but that it might still lower it.

One of the biggest questions after the downgrade was what impact it would have on already nervous investors. Some selling was expected when stock trading resumes Monday morning. The Dow Jones industrial average fell 699 points this week, the biggest weekly point drop since October 2008.

One fear in the market has been that a downgrade would scare buyers away from U.S. debt. If that were to happen, the interest raid paid on U.S. bonds, notes and bills would have to rise to attract buyers. However, even without its AAA rating, U.S. debt is seen as one of the safest investments in the world.

S&P said that in addition to the downgrade, it is issuing a negative outlook, meaning there is a chance it will lower the rating further within the next two years.

So, according to The Indianapolis Star and Associated Press, S&P downgraded the US credit rating because Congress “failed to cut enough government spending to satisfy S&P.” Only guess what? Here’s what S&P actually said (emphasis added):

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Standard & Poor's takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.'s finances on a sustainable footing.

In other words, as I read S&P’s statement, US credit was downgraded because of the difficulty that Congress had in negotiating ways to contain the growth in future spending and raising revenues. Hmm. Now unless I’m mistaken, that AP article published by The Indianapolis Star never once, not ever, mentioned revenues and laid the entire blame on the failure to cut government spending. Thus, AP, and by extension, The Indianapolis Star, essentially lied to readers by giving only one-half of the explanation.

As I’ve been saying in relation to this and other subjects, how can the American electorate make any kind of informed decisions when the information that they get is unreliable or false?

Finally, when it comes to deciding who you should blame for the downgrade (and the resultant effects therefrom), remember that Speaker John Boehner (R-Ohio) claimed that the debt deal gave Republicans 98% of what they wanted. Hmm. If they got 98% and the result was a downgrade, then doesn’t that mean…? Or perhaps this video from a Wisconsin tea party rally this past weekend will help illustrate the point:

 

Did you catch that? The speaker notes that people are blaming the Tea Party for the downgrade … and the audience (well not the old fogies whose backs we see in the video) cheers. I’m thinking that if you’re cheering for the downgrade then you are, essentially, owning it. So remember, if your mortgage rate goes up or your credit card interest rate goes up or anything else becomes more costly or difficult (as I write this, the Dow is down about 350 points today) because of the downgrade: Republicans got 98% of what they wanted … and the Tea Party cheered.


*I cannot confirm that this is the exact format in which the article appeared in the print edition of the newspaper. However, the omissions that I discuss were similarly omitted from the print edition (which is what led me to write this post in the first place).

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