06 August 2011

Standard & Poor's Downgrades U.S. Credit Rating

Highlights from the Standard & Poor's press release on downgrading the credit rating of the United States from AAA to AA+, with commentary:
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.

Do you suppose that S&P took notice when Senator Mitch McConnell cheerfully declared that hostage taking was the new legislative norm henceforth?  Do you suppose that was a reckless, stupid thing for an elected official to brag about?
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.

Yup, they noticed.  Yup, it was a reckless, stupid thing to say.
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.
S&P affirms what both parties have been shouting: we tax too little and spend too much on Social Security and Medicare.  Only before you take this as evidence that SS and Medicare need to be completely gutted, read on.
The act calls for as much as $2.4 trillion of reductions in expenditure growth over the 10 years through 2021. These cuts will be implemented in two steps: the $917 billion agreed to initially, followed by an additional $1.5 trillion that the newly formed Congressional Joint Select Committee on Deficit Reduction is supposed to recommend by November 2011. The act contains no measures to raise taxes or otherwise enhance revenues, though the committee could recommend them.

So S&P also noticed--as did all the angry Democrats--that the debt ceiling deal does not raise revenue, because the Republicans refused to compromise on that point.  How inspiring was the revenue-free deal?
Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act. Key macroeconomic assumptions in the base case scenario include trend real GDP growth of 3% and consumer price inflation near 2% annually over the decade.
Maybe now that Standard & Poor's has made clear that refusal to let the Bush tax cuts expire is a bad thing, someone in the GOP will finally be reasonable about letting them die.

Our revised upside scenario--which, other things being equal, we view as consistent with the outlook on the 'AA+' long-term rating being revised to stable--retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, we project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 77% in 2015 and to 78% by 2021.

Our revised downside scenario--which, other things being equal, we view as being consistent with a possible further downgrade to a 'AA' long-term rating--features less-favorable macroeconomic assumptions, as outlined below and also assumes that the second round of spending cuts (at least $1.2 trillion) that the act calls for does not occur.
Back to not trusting Congress to make good on the debt ceiling deal.  Now for some money talk about interest rates:
This scenario also assumes somewhat higher nominal interest rates for U.S. Treasuries. We still believe that the role of the U.S. dollar as the key reserve currency confers a government funding advantage, one that could change only slowly over time, and that Fed policy might lean toward continued loose monetary policy at a time of fiscal tightening. Nonetheless, it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.

Will interest rates increase in response to our credit rating being lowered?  According to everyone who warned that constantly threatening to shut down the federal government if it didn't agree to plans to gut the federal government was a bad thing, yes.

When comparing the U.S. to sovereigns with 'AAA' long-term ratings that we view as relevant peers--Canada, France, Germany, and the U.K.--we also observe, based on our base case scenarios for each, that the trajectory of the U.S.'s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.

Now, what I'd like to note about this paragraph is that every one of our peer countries mentioned in that paragraph provide universal health care to their citizens.  They're in better economic shape than we are.  They are, however, in better physical shape than we are and they have much more reasonable health care industries.  If they can do it, there's no reason we can't do it except for the fact that some of us don't want to do it.

In summary, then, Standard & Poor's has just told us--in full view of the entire world, no less--the following:
  • Hostage taking and constantly threatening to shut down the federal government and/or default on our debts is no way to run a country.
  • There is no belief that Congress will even honor its own feeble, revenue-less plans; much less begin operating responsibly.
  • We must increase revenue.
  • While entitlement programs are costly, other countries manage to provide full universal health care while operating more responsibly.
I hope you're all happy, "shut it down!" Tea Party people.  Your shenanigans and obsession with refusing to raise revenue while "sticking it" to President Obama has colored us as so childish that Standard & Poor's doesn't trust us to even run a country befitting a world leader.  And make no mistake: it is the constant shenanigans that are responsible for this lack of faith in our ability to manage our books properly.

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