S&P Downgrade - Onions Have Layers, Ogres Have Layers

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?

Obama Love

I have been bashing on Obama lately, and I expect it to continue for quite some time. But just to show that I am a good sport, I am linking to a well-written post by Kevin Drum (hat-tip Dave Benen) that suggests Obama has been very effective.

What’s more, Obama also won passage during his first two years of a stimulus bill, a landmark healthcare bill that Democrats had been trying to pass for the better part of a century, a financial reform bill, and much needed reform of student loans. And more: a firm end to the Bush torture regime, the Lily Ledbetter Fair Pay Act, a hate crimes bill, a successful rescue of the American car industry, and resuscitation of the NLRB. Oh, and he killed Osama bin Laden too.

In fact, I think the post has given me something to think about. Obama has accomplished many good things for the liberal agenda - although I am far from convinced that this makes him the most effective president since Reagan or Johnson.

But his accomplishments in his first two years don't give him a free pass for his second two years. Good liberal accomplishments don't excuse how much he has moved away from liberalism after Healthcare and the 2010 elections. And because he has moved away, the country has gone to the right with him. I will continue to feel that recent events have shown him unwilling to stand up for what he believes in if he thinks those things are currently unpopular.

Drumm also reminds me of the deals that Obama secured during the lame duck session - deals that are worthy of praise. And maybe it is true that he couldn't have gotten a debt ceiling increase then also. But that doesn't mean he had to negotiate in the feckless manner that he did.

He acted in good faith and trusted the Republicans to do the same, which was clearly a mistake. Worse, he let himself get pulled into the wrong fight instead of talking about jobs and beating the Republicans up for not talking about jobs. Now both groups look out of touch, which is bad for the Republicans in Congress, but bad for Obama, too. He handled this poorly, and I think he will pay by losing a second term.

Update - More Posts that Don't Blame Obama
There is a good post at the Economist linking to some people that go easier on Obama and blame all of us for not convincing America that the liberal version of government is better. I don't disagree; we can all share the blame with Obama. Here is Drumm again, quoted in the post:

I blame the broad liberal community for our failures, not just President Obama. My biggest beef with Obama is the same one I had three years ago, namely that he's never really even tried to move public opinion in a specifically progressive direction. But that hardly even matters unless all the rest of us have laid the groundwork. And we haven't. Wonks, hacks, activists, all of us. We just haven't persuaded the public to support our vision of government. Until we do, the tea party tendency will always be more powerful than we are.

Dreaming of Christie in 2012

If we are going to have a Republican president in 2012 (and we are), I wish it could be Chris Christie. Sure he’d try to cut the size of government and attack unions, but he at least seems to have some courage and decency. Here's a good example, where he strongly defends his appointing of a Muslim-American as a judge in New Jersey.

Obama's Two Flaws

President Obama has two (at least) flaws that are proving to be fatal right about now. First, and this is probably his worst flaw, he thinks he can change the world with one speech. To the extend that he articulates and defends his policies, he does so once. Meanwhile, Republicans are out there parroting their positions over and over again, to pretty good effect.

Obama said from the beginning that he wouldn't play into the 24 hour news cycle. While that keeps him from getting involved in some of the fast burning and quickly forgotten stories, it also means he isn't effectively at setting the agenda and defining the issues. If he wants to compete with Republicans, he needs to be hammering home his message - which as the leader of the Democratic party, it should be a fairly liberal message - all day everyday.

Second, he has decided that above all he should be reasonable and centrist. I'm not exactly sure why but I have a few guesses. Maybe he actually thinks that if he is reasonable, the other side will be reasonable as well. If this is why, he should have learned already that this isn't true and only makes him a terribly ineffective negotiator. He made this mistake with the stimulus, health care, and now the debt limit.

Or maybe he thinks it will help him win reelection. This is a mistake as well. His moderate policies are bad for this economy, which means he will go into reelection with a stagnant recovery or worse a double dip recession, and therefore seen as ineffective. Moderate, but ineffective doesn't sound like a good strategy for reelection.

How About Some Fun and Thoughtful Econ?

I have been spending too much time in the ultimate of frustrating activities: hoping to convince (or more likely see someone with a wide audience convince) Republicans that cuts to programs or increases in taxes in the short term will hurt the economy at a fragile time. Unfortunately, Republicans aren't reasonable and will not bother trying to understand economics; government is bad and cuts must be made now. So as our country careens towards a lost decade, let's spend some time on a less urgent issue and in a more reasonable fashion.

Casey Mulligan - who seems to be a pretty conservative economist - has been writing a lot lately on labor supply and labor demand. His main point seems to be that labor supply can be just as important (or not meaningless?) as labor demand during a recession. In this post, he uses a comparison between summer employment and Christmas / holiday employment to show the difference between the demand and supply side. During the holidays, demand for labor increases. During the summer, supply for labor increases.

Casey Mulligan says that summer employment shows that an increase in the supply of labor can increase total labor. Now, there are a few things I don't fully understand about his charts. He says total labor increases, which I can't see for sure. But it also looks like wages decrease, which isn't a good thing. Though I guess more jobs with lower wages is better than less jobs and stagnant wages. If this is part of his point, he leaves it unsaid.

His policy prescription that follows from this data is that unemployment benefits decrease labor supply and therefore total labor. To the extent that this is true, it matters how big this affect is. By decreasing benefits, we are hurting unemployed families, especially the ones that still can't get jobs. So if the effect is marginal, than we would probably want to keep the benefits. If the effect is significant, then... well then I don't know. I don't love the idea of letting families go into poverty just to induce them to work more.

While I am probably willing to concede that labor supply is not meaningless, I still think that labor demand is the much bigger factor at this point. Business surveys suggest that lack of sales are driving the lack of hiring. So while decreasing benefits, as cold-hearted as it seems, might increase employment, I can't imagine it having a major impact. I think we need to work on the demand side to really drive down unemployment.