So S&P downgraded US debt. Let me first say that I don't think the downgrade is justified or wise. Their reasons are both political and fiscal - neither of which fully support downgrade in my opinion - even taken together.
They say that the debt limit deal is not enough to give them confidence in the US medium-term debt situation - in other words, they wanted deeper budget cuts. But I haven't seen anyone except uninformed politicians suggest that we have a short- or even medium-term debt problem - in other words our current debt as a percent of GDP - or projected debt in the medium term - is not a risk (France and UK have higher levels and are still AAA). The concerns lie in the long term. And if you want evidence of this, look at interest rates on our government bonds.
Also, I don't think anyone believes that S&P would have downgraded if this debt limit nonsense had not happened. In other words, it isn't really about fiscal policy at all, but they can't justify using politics alone so they cooked up some fiscal nonsense.
As for the politics, I agree that it is deeply troubling that we were on the brink of defaulting on our debt (all because of an arbitrary debt ceiling where Congress has to approve spending it has already approved). And we were on the brink due to politics; Republicans wanted big spending cuts, and chose to extract them by showing a willingness to default on our debt. I think everyone agrees that was terribly irresponsible.
However, I don't think the troubling nature of what happened is as bad as they make it out to be. We didn't default on our debt and the debt ceiling won't be up again until 2013. And for all we know, future Congresses might raise the debt ceiling as a matter of course, like previous Congresses did over 100 times.
As for how this plays out politically, by using both fiscal and political reasons, S&P seems to be trying to pass the blame around - ie the budget cuts were not enough and Republicans were crazy. And both parties will blame the other (as they also go on the attack against S&P). And voters will continue to blame both parties for this, but probably the Republicans in Congress a little more. (Even Meghan McArdle at the Atlantic - a serious conservative - blames the GOP Congress.)
In theory, it should also completely ruin Michele Bachmann's campaign. She all along opposed raising the debt ceiling and seemed to think default is no big deal. (She was the most outspoken, but to be honest, I don't know what the other candidates said.) Unfortunately, I'm not sure it will. I think Bachmann's base will agree with her no matter the evidence.
While voters will blame Obama, I don't completely blame him for the downgrade. All along I have been critical of him because he has not lived up to what I want in Democratic president and who I thought I was electing. But I should make it clear that Republicans deserve most of the blame for where we are. Sure, Obama didn't have to let himself get dragged into this debate, or at least he didn't have to let Republicans dictate the terms, but he wasn't driving it.
I also think (and hope) that this is going to play out badly for S&P. They already have a significant credibility problem because of their role in the financial crisis and all the junk bonds they rated AAA. In fact, Noam Scheiber had this funny tweet, "What if we bundled bonds from our 10 dodgiest states, sliced them up, re-packaged them w/other dodgy slices. Could we keep AAA rating then?" Their decision to downgrade is far from a slam dunk and as I said I think both parties will go on the attack. And the fact that they had a $2 trillion math error isn't going to help. The bottom line, this was a risky decision and they don't have the credibility or trust to back it up.
What remains to be seen, and is probably the most important part of S&P's decision is how it plays out. Will other rating agencies follow suit, or will they leave S&P hanging? And will the markets react at all? I hear that federal debt should be fine because most investors know that the fundamentals are fine. However, state and local governments may see increased borrowing costs.
If that happens, we have to wonder whether it was necessary. I obviously say no. This was clearly a political statement by S&P not an objective decision based on the numbers. So now we might have higher costs just so S&P could join the fray. Are there no adults in this debate?
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