Downgrade!

S&P does the deed, despite the arithmetic. The problem isn’t economic, it’s political.

Standard and Poor, which continued to rate various junky derivatives AAA until they went into default, has downgraded the debt of the United States of America. This can’t be based on the possibility that the government will be unable to pay its debt – after all, the debt is in dollars, and we own the printing press – but rather on the possibility that the hostage-takers in the GOP caucuses in Congress will eventually decide to shoot a hostage, forcing the government into default. The other agencies are holding steady.

Even a minor increase in Treasury borrowing rates will do large damage to the world economy. Thank you, John Boehner. Thank you, Mitch McConnell. Thank you, Pete Peterson. Thanks are also due to the Koch Brothers and their useful idiots in the Teahadi movement. Let’s say it now: their actions have, from the beginning, been as unpatriotic as those of any important American political force since Secession.

But it’s also worth noticing that the analysis S&P gave the Treasury when it warned about its plan to downgrade was off by $2 trillion. The Treasury pointed out the error. Apparently that didn’t matter; S&P had decided to downgrade and went right ahead. After all, what’s $2T among friends?

Is it just possible that some S&P employees had shorted Treasuries, or something else likely to get hit? It appears that part of the explanation for yesterday’s stock-market crash was that word of the possible downgrade had leaked.

Might this be a good time for a serious investigation into the ratings-agency racket?

Footnote Just this once, could Barack Obama allow himself to become visibly, righteously angry at the people who have brought the national honor into question?

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

37 thoughts on “Downgrade!”

  1. “This can’t be based on the possibility that the government will be unable to pay its debt – after all, the debt is in dollars, and we own the printing press”

    Creditors, of course, are not particularly concerned with whether they are paid back in nominal terms, as you are no doubt aware. They want to be paid back in an amount of currency which carries more value than the currency they loaned. This means that the simple fact that the US can print an effectively infinite number of dollars does nothing to reassure our creditors. Rather, it is a source of worry for them, because they know that, at any time, we can render their loans effectively valueless without violating their black letter terms. They can loan us currency worth a billion loaves of bread, and get paid back twice the nominal sum, and find it only buys a half billion loaves.

    So, yes, S&P certainly can be concerned that the government will be unable to pay it’s debt on terms creditors would view as not causing them a loss.

    The ratings agencies have been quite clear about why they’ve considered, and now begun, downgrading our credit rating. Because we’re on a trajectory towards unsustainable debt, and even if we don’t default in nominal terms, we will probably end up cheating our creditors by inflating their loans into worthlessness.

  2. Brett, you’re wrong. This is not a matter of opinion. Your statement is contrary to fact. I’ve protected you from rudeness. But your willingness to make baseless claims does not do you credit, nor does it add to the quality of the discourse here.

    If the problem were inflation, the downgrade would apply to all dollar-denominated debt. But there are lots of corporate dollar bonds still rated AAA.

    The ratings agencies aren’t investment advisers. Their job is to rate the probability that a security will not be paid according to its terms on the due date. That is all.

    Gus, I’m not committed to the claim that Barack Obama is infallible: only that he’s the leader of my team, and that the world will be a better place, as I evaluate it, if he succeeds rather than failing.

  3. But there are lots of corporate dollar bonds still rated AAA.

    Doesn’t this illustrate the absurdity of the downgrade? Who in their right mind could possibly believe that if the Treasury defaults on a debt obligation, private companies will continue to meet theirs?

  4. Indeed, at some point the risk of hyperinflation will merit downgrading all debts denominated in dollars. In the mean time, there are special risks loaning money to sovereigns. I simply believe that we ought to take S&P at their word for why they’re doing this.

    Or, of course, we could try to extort a higher rating out of them by threats of legal action if they don’t provide it. Somehow, I don’t think that will reassure our creditors, though. Perhaps S&P could give us a special “AAA because we don’t want to be jailed” rating…

  5. “Who in their right mind could possibly believe that if the Treasury defaults on a debt obligation, private companies will continue to meet theirs?”

    Why, anybody who understands that the US government becoming over-extended doesn’t imply Microsoft becoming over-extended, and that governments have more tools for cheating their creditors than private industry possesses.

  6. Since pension funds own so much stock, why can’t/don’t they band together and create their own rating agency?

  7. Of course S & P is 100% full of baloney. We would close shop on Medicare and Social Security before bondholders would lose a nickel. The real reason for the downgrade is payback for Dodd-Frank, but S & P is so incompetent that they don’t get that the downgrade may hurt the GOP more then it does Obama.

    Just more Republican hacks masquerading as professionals.

  8. I’m generally not a “look on the bright side” kind of person but, look on the bright side: This is in good measure a rebuke of Republican intransigence. Part of S&P’s rationale is their expectation that the Bush tax cuts will be extended due to Republican opposition. Maybe this can be used to force the inclusion of more revenues and for, the love of pete, stop dicking around with discretionary spending and tackle the big rock: defense spending.

    Even so, this is going to damn the majority of Americans to a 10-12 year span of economic bleakness. It’s going to change us all for the worse. I can’t even imagine it.

    The 2012 election may be characterized as a race to lose the office of the Presidency. Expect a Bachmann/Cain ticket.

  9. “Is it just possible that some S&P employees had shorted Treasuries, or something else likely to get hit? It appears that part of the explanation for yesterday’s stock-market crash was that word of the possible downgrade had leaked.”

    S&P should have been shut down for its role in the collapse of all those “pieces of crap” (direct quote of some investment banker) it gave its highest rating to, in spite of ample and obvious evidence that it all was just crap.

    I think Treasury-shorting by S&P isn’t just possible, but likely, and I also think S&P believes that this downgrade will intimidate government regulators from too closely investigating their lapses (read: collusion) in how they rate equities.

    The one thing S&P said that is true is:

    “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 challenge.”

    This shows that they do recognize intransigence and the complete refusal to even entertain the idea of compromise when they see it (hello, Tea Party folks) and IF this downgrade is merited (which I do not believe), this is most like the source of the problem. Investors do not like having additional unpredictability inserted into their game.

    I think anyone who was paying attention to Washington DC for these past months had to have experienced great stress and despair for our nation and our economy, and it could be that this general duress is the basis for the S&P downgrade regardless of whatever mathematical evidence they toss in for good measure. Governance isn’t just a game, and it appears the threat of willy-nilly defaulting without cause has had its effect. Thanks Tea Party folks! Perhaps your masters will take notice.

  10. Just this once, could Barack Obama allow himself to become visibly, righteously angry …

    I’ve seen 14-year old Chihuahuas with bad hearts shivering in the snow with more get-up-and-bark…

  11. It may be too late for the President to get angry. How will he explain to the electorate that American debt was downgraded for the first time? Will this lead to the dollar’s demise as the world’s a reserve currency? in any event, while Democrats will be pondering the economic consequences of S&P’s questionable decision, the wingnuts will use it to blame somebody new to plot new extortions against anybody in their way. Such is the state of our recently fragile democracy. So, while some tea-party-ers are gathering down the hall in the House chambers for their putsch on America, the Senate millionaires will ignore them, sip their bourbon, and wait for the crowd to disperse. Senators best lock their chambers’ doors and put their drinks down lest they become hostages themselves.

  12. Brett, if I recall correctly you work on rocket engines or something like that. Should the topic of rocket engines ever be relevant here, I will happily defer to your professional expertise. Credit ratings have, however, at most a highly attenuated connection to that expertise. They are a key point in mine (such as it is). Mark is right, and you are wrong. You can withdraw now with your dignity intact, or you can keep digging and make an ass of yourself.

  13. Rocket engines were a hobby, I design tooling for deep draw stampings.

    I do not believe I’ll embarrass myself, (Though you may regard me as embarrassed…) if I observe that, while I am not an expert in credit ratings, S&P is. And they have explained why they downgraded it. That you may find that explanation uncongenial does not make it a lie.

  14. Brett,

    S&P might not be lying. (They probably aren’t; if I were SEC Enforcement I’d surely want a look at the recent trading patterns of certain S&P personnel, but individual malfeasance is a different matter.) But what they have done is not what a rating agency is there to do; and why they have done it is not why rating agencies are supposed to do it.

    And: experts in credit ratings? a few years ago, I might have accepted that. Even today, I’m reasonably confident that, if given access to the proper documentation (and assuming that documentation is accurate), they probably can assess the likelihood of default on a plain vanilla debt instrument somewhat more accurately than random guessing. That is not,as they say, rocket science. No, what S&P, Moody’s and Fitch are expert at is exploiting the opportunity to extract oligopoly rents that a beneficent deity, in the form of the US Congress and Securities & Exchange Commission, have gifted them. Well, what the Lord giveth, the Lord sometimes taketh away, and S&P are now at very real risk of having their milkshake drunk. That they are hissing and clawing in response is not surprising. That they are going about it idiotically is as little surprising; during the CDO catastrophe the rating agencies repeatedly and conclusively proved themselves the stupidest guys in the room.

    Machine tools, rocket engines: it’s all brain surgery to me.

  15. @mark–is my continued insistence that brett is a comedian of the dead-pan ironic type a form of rudeness? i’ll desist in saying it if you consider it as such but that referential frame makes his posts both more explicable and pretty funny.

  16. Anyway, you want embarrassing, Mark’s assertion that nobody should be concerned about the US not paying it’s debts, because we can print money, qualifies.

  17. Nah, he can’t do that: Taking that explanation seriously would imply that Republicans aren’t solely at fault.

  18. Marcy Wheeler and others are saying the S&P downgrade could cost each and every American $322 per year going forward. Add that to the 2008 financial losses, partially engineered by S&P triple-A stamps on junk, and what is the net present value of the damages, per American, caused by S&P in the last 5 years?

  19. S&P specifically refers to continued confidence in the US dollar as the key reserve currency, so I’m not sure what Britt is talking about.

  20. Yes, I read the S&P statement. It’s gibberish, unless it means that they think at some point the Teahadis will deliberately force a default. I repeat: it is simply not the case that a sovereign that prints its own money can ever be in a position where it can’t pay its creditors. And since the Constitution requires that the public credit be honored, it is also not the case that the United States can default by force majeure. I’m glad to have Mrs. Tilton’s support, but this not a technical question about finance: it’s a purely logical question, with only one answer.

  21. Yes Mark, the Tea/GOP pulling the plug seems to be the only rational excuse. It begs a question: If the Tea Party caucus all boarded a plane to go kiss the rings (or some other thing) of the Brothers Koch and the plane crashed, would S&P reinstate USA’s state of blissful financial good standing? I somehow doubt it.
    I’d wager there is some ulterior motive to S&P’s action… but that would be silly to think that people involved in high finance would be duplicitous. Why it fairly smacks of… a conspiracy theory. And we all know there are no such things as conspiracies.

  22. “I repeat: it is simply not the case that a sovereign that prints its own money can ever be in a position where it can’t pay its creditors.

    And since the Constitution requires that the public credit be honored, it is also not the case that the United States can default by force majeure.”

    And I repeat, that’s simply irrelevant, since creditors are not reassured to know that they could be paid back in worthless currency after a hyperinflation. Or be paid back in full, only to have their newly enacted 90% “debt payment tax” withheld from the payment.

    Loaning money to sovereigns is inherently risky, in ways loaning money in the private sector isn’t. Once a sovereign decides that it’s going to cheat it’s creditors, it has no end of ways to accomplish this. The 14th amendment wouldn’t stop it, and the printing presses are a way to cheat creditors, not an alternative to cheating them. And when you take exception to being cheated, you must do so in the sovereign’s own courts, if it deigns to permit you to.

    So S&P quite properly has to look at the increasing likelihood that a future US government will have reason to cheat its creditors. Our unwillingness to change a trajectory towards unsustainable debt, either by tax increases OR spending cuts, gives them every reason to suspect this. Now, of course, people are talking about mounting various legal attacks on S&P for having the nerve to do this, which easily predicted consequence explains why other ratings agencies are, as yet, only making noises about downrating us. Nobody wants to be first to tell the Emperor he’s naked, because pissing him off isn’t particularly safe.

    Finally, that you find S&P’s explanation for why they downgraded us politically unsatisfactory does not make it gibberish, or make it reasonable for you to substitute reasons you’re more comfortable with for the ones they actually expressed.

    “Denial ain’t just a river in Egypt”, as they say, and you’re diving deep here.

  23. If there is hyperinflation and the US dollar is so devalued, then it would cease being the key reserve currency. S&P clearly states they don’t see this happening. Brett, you’re living in la la land.

  24. @mark–seriously, doesn’t it make more sense that brett is doing conceptual stand-up. i laugh every time i read him. again, if it’s rude of me to publicly take that perspective i’ll stop.

  25. Putting AAA-rated corporates to the side for a minute, this quote illustrates the absurdity of the situation:

    “S&P still rates 13 U.S. states at AAA.”

    http://reut.rs/nee9UV

    There’s an extended discussion over what debt S&P is expected to downgrade soon (Fannie and Freddie and pre-refunded bonds that are backed by Treasuries) and a discussion of longer-term concerns (that budget cuts will eventually impact state and municipal budgets), but no suggestion that downgrading their sovereign (and single largest revenue source) would have any sort of inevitable impact on those states. Huh?

  26. The S&P press release said they are projecting US inflation to be somewhere between 1.5% and 2%, so clearly they are not basing their decision on a risk of hyperinflation.

  27. There was a much-passed-around paper on synthetic CDSs that (if my memory serves me correctly) pegged the bottom of the risk bin for AAA as roughly 1% (i.e. if you held 100 representative AAA securities to maturity, one of them would fail to pay off as contractually specified.) Hands up anyone who thinks that more than 1 of the next 100 series of notes the Treasury issues will fail to pay off as specified.

    Btw, if anyone at S&P was shorting treasuries they’re likely out a pile of money, since the market tanked everything else but didn’t particularly seem to think that treasuries are in danger.

  28. Yields on treasuries are down. I guess creditors don’t share the same worries as S&P or Brett.

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