S&P Was Right to Downgrade

August 8th, 2011 at 4:34 pm | 26 Comments |

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The dispute between the Treasury Department and Standard and Poor’s over America’s sovereign bond rating is a tempest in a teapot.  Worse, it overshadows the reality about America’s debt: Congress cannot handle it politically and Americans will have difficultly handling it personally.

The facts about America’s fiscal status don’t allow for much debate.

Depending on whose baseline economic forecast you use, the United States will have sovereign debt at about 100% of GDP in a decade.  We base those estimates on the slower-than-forecast growth of the past year and the probability that growth over the next two quarters will be slower than in the Congressional Budget Office baseline forecast.

Anyone predicting two years out, let alone 10 years, risks about a 90 per cent change of being very wrong.  The dispute between Treasury and S&P’s baselines is a little like predicting how good the Washington Capitals are going to be in 2021. As the poet wrote, “So much/depends….”

So what are the unadorned numbers?  So much depends on:

*will the Joint Select Committee on Deficit Reduction come up with a broad-based, fundamental change in America’s structural fiscal dilemma?

*what will Congress do at the end of this year with the Alternative Minimum Tax, the Medicare re-imbursement for doctors, Unemployment Insurance, and expiring tax cuts?

*what will happen to the Bush tax cuts in 2012—will all be extended, only lower income provisions, nor none at all?

*will troop withdrawal from Afghanistan and Iraq proceed on schedule?

*will America undertake military action in some other part of the world?

*will the very slow recovery continue, with unusually high joblessness for this period in a recovery?

*will an aging society spend less than historical levels on consumption and save more than the post-World War II average?

*is America in the fourth year of a “lost decade,” as some predict?


One could add lots of other unknowables:  Pakistan deciding to attack India; further unrest in oil-producing nations;  collapse of the EU; a large meteorite hitting earth.

What do we know?

Recent history gives us guidance.

In 2008, the Congressional Budget Office predicted that real GDP would grow by 1.7 per cent in 2008, by 2.8 per cent in 2009 and by 3.5 per cent in 2010. Sit down for the real numbers:  -0.3 in 2008, -3.5 in 2009, 3.0 in 2010.  The CBO then forecast 3.4 per cent for 2011 and the present growth path looks somewhere around less than 2 per cent.

It wasn’t just on growth that CBO (after consultation with many outside economists of note) erred.  In 2008 it forecast unemployment of 5.1, 5.4, 5.1 for FY08-10.  The real numbers were 5.3, 8.5, and 9.8.

Deficit projections were just as stark.  FY08 was supposed to show a deficit of $218 billion.  Real number?  $455 billion.  For FY 09, $198 billion predicted, -$1,414 billions (1.4 trillion) reality.  For FY 10, -$241 billion and reality of $1.3 trillion.

And just for the sake of black humor, let’s note that CBO forecast a surplus of $87 billion for FY12.  Current forecast, -$1.1 trillion.

This isn’t to pick on CBO at all.  Indeed, CBO was slightly more pessimistic in its forecasts than the general consensus of economic analysts and more pessimistic than the Office of Management and Budget, the President’s fiscal forecasters.

But, the underlying theme is undeniable—while the nature of America’s economy was changing before their very eyes, most forecasters missed things entirely.

What about the future? At the risk of undermining the foregoing argument, let’s sneak a peek.

If history is any guide,  growth will continue slower than forecast, unemployment will remain higher, and deficits will be whigher for at least a few more years. That’s what the Great Depression historians, of which Chairman Bernanke is an acknowledged expert, tell us happens when a nation recovers from a financial recession.

Summary: deficits continue to rise, debt accumulates more rapidly than forecast, demographics continue to make the present Medicare, Medicaid, and pensions systems of the United States unsustainable.

Of note: that word, “unsustainable,” was used by President Obama, Fed Chairman Ben Bernanke, the President’s fiscal commission, the Bipartisan Policy Center’s Debt Reduction Task Force, and by almost every other analyst on the globe.

Now, let’s ask that question again, “Was the S&P wrong to downgrade the future of United States debt?”

One of the saddest comments of all came from President Obama earlier today.  Instead of ordering Congress back into session from its August vacation, instead of outlining a short, tough overall plan for growth and debt reduction, the President said, basically, ‘well, gee, we have to do something.’

Maybe The Economist magazine is right—one weeps at the leadership of the Western nations.

Recent Posts by Steve Bell



26 Comments so far ↓

  • Oldskool

    Or maybe he knew it was pointless to call Congress back since they have a schedule and their refusal would have boggers announcing his demise. Be grateful we have someone intelligent as president who doesn’t look like a nitwit at every opportunity.

    • Smargalicious

      I don’t buy it. I just think the president isn’t very bright.

      Socrates taught that wisdom begins in the recognition of how little we know. Mr. Obama is perpetually intent on telling us how much he knows. Aristotle wrote that the type of intelligence most needed in politics is prudence, which in turn requires experience. Mr. Obama came to office with no experience. Plutarch warned that flattery “makes itself an obstacle and pestilence to great houses and great affairs.” Today’s White House, more so than any in memory, is stuffed with flatterers.

      Much is made of the president’s rhetorical gifts. This is the sort of thing that can be credited only by people who think that a command of English syntax is a mark of great intellectual distinction. Can anyone recall a memorable phrase from one of Mr. Obama’s big speeches that didn’t amount to cliché? As for the small speeches, such as the one we were kept waiting 50 minutes for yesterday, we get Triple-A bromides about America remaining a “Triple-A country.” Which, when it comes to long-term sovereign debt, is precisely what we no longer are under Odumbo.

      Then there is Mr. Obama as political tactician. He makes predictions that prove false. He makes promises he cannot honor. He raises expectations he cannot meet. He reneges on commitments made in private. He surrenders positions staked in public. He is absent from issues in which he has a duty to be involved. He is overbearing when he ought to be absent. At the height of the financial panic of 1907, Teddy Roosevelt, who had done much to bring the panic about by inveighing against big business, at least had the good sense to stick to his bear hunt and let J.P. Morgan sort things out. Not so this president, who puts a new twist on an old put-down: Every time he opens his mouth, he subtracts from the sum total of financial capital.

      Then there’s his habit of never trimming his sails, much less tacking to the prevailing wind. When Bill Clinton got hammered on health care, he reverted to centrist course and passed welfare reform. When it looked like the Iraq war was going to be lost, George Bush fired Don Rumsfeld and ordered the surge.

      Mr. Obama, by contrast, appears to consider himself immune from error. Perhaps this explains why he has now doubled down on Heckuva Job Geithner. It also explains his insulting and politically inept habit of suggesting—whether the issue is health care, or Arab-Israeli peace, or change we can believe in at some point in God’s good time—that the fault always lies in the failure of his audiences to listen attentively. It doesn’t. In politics, a failure of communication is always the fault of the communicator.

      http://online.wsj.com/article/SB10001424053111904140604576495932704234052.html

  • ottovbvs

    Total rubbish. There is no threat to US creditworthiness or why did ten year T bills close at 2.3%? And if it was justified why didn’t the other two major agencies join them because they usually do?

    • jamesj

      Bingo. Why downgrade the US when its debt to GDP ratio is lower than many other AAA rated countries in Europe and elsewhere? Because it was a political statement about the decay of the political machine in Washington, not a statement about debt.

      As the extreme faction in the House bluffed its way through the last 2 months they poked world markets and every investor in US dollars in the eye with a large stick. All the while they vigorously claimed on their ideologically pure radio shows and news channels that they were just trying to fix a debt problem and default was no big deal anyway, in stark disagreement with virtually every economist and analyst well-versed in these issues. And now we’ve come to this, having provoked the credit agencies and investors without need. And you know what? There are few negative political consequences for what they’ve done. That is the sad part.

      I honestly view someone who would vote for more of this as the biggest danger to this country’s well being over the next couple decades.

  • think4yourself

    I agree with Steve Bell (but I don’t like it). The S&P downgrade was about the medium and long-term issues. Not what the financial condition is today. The today trigger is the inability of the politicians to do more than stick their head in the sand (when you see a train coming, one ought not just sit on the rails placing the blame elsewhere).

    We can scream at S&P that they are the villian and will cause more pain to the economy and they will. On the other hand, is there ever a time to make painful corrections?

    The Bowles/Simpson Debt Commission, Obama’s Grand Bargain, David Walker’s plan – all of these ought to be considered with cuts and revenue. Don’t push cuts out 10 years, but do it soon.

    Democratic politicians screaming the Republicans want to take your Social Security and Tea Partiers screaming the liberal/commies want to bankrupt the country aren’t fixing the problem. They are the problem. Spend less than you take in or cut spending and raise revenues.

    • ottovbvs

      “I agree with Steve Bell (but I don’t like it). The S&P downgrade was about the medium and long-term issues”

      As conservative economist Ken Rogoff pointed out on the newshour tonight a downgrade of the US to double A when France and Britain have triple A is a bit goofy. This is a very widespread US opinion from Warren Buffett on down. Basically they were making a political opinion not one based on our creditworthiness. And that is not how rating agencies are supposed to arrive at ratings. A

      ” On the other hand, is there ever a time to make painful corrections?…Don’t push cuts out 10 years, but do it soon”

      I see, the US economy is moving at stall speed and you believe this is just the right time to make painful corrections (ie. cut spending?) and thereby further reduce demand. And you think this will cause overall economic activity to increase, employment to rise and equity markets to rally? And you run a financial company? Say hello to Herbert Hoover and Andrew Mellon for me.

      • Idle Resources

        Karl Rove said the same thing elsewhare. Ottobs is his poodle.

      • think4yourself

        Very funny. I do run a financial services company (equipment leasing, 21 years same company, 11 as the owner). I also have no debt and am paying my house off at the end of this month. That happened even though over the last 2 1/2 years we have lost virtually all of our banking sources and had to start over. Nor did we fire any employees. We have also watched over half our competitors go out of business. The difference is that we have always believed in being prudent regarding debt.

        There is a place for debt. It can be a valuable tool when it’s clear that a debt investment will lead to greater returns than the cost of repaying the obligation plus the interest cost. However, most people never actually count that cost, just blithely assume that they can afford the monthly payment and never think about what will happen if something unexpected occur. Then they exclaim “it wasn’t my fault”.

        I would take Obama’s grand bargain, or Bowles/Simpson today in a heartbeat. If we had done so, there wouldn’t be the S&P downgrade. I also agree with the President that the US is not defaulting. If the US does make tough choices (increase taxes, make real spending cuts – which is in doubt as exhibit A see the medicare “Doc fix” http://voices.washingtonpost.com/ezra-klein/2010/06/what_to_do_about_the_doc_fix.html, we’ll be in a great position to respond when China stumbles. If not, we’ll be like Japan is now. To me that is worth some short term pain (and I know it’s painful, has been for us).

        • ottovbvs

          I do try to leven my acerbity with some humor. I’m glad you saw the right side of it. I’m not unfamiliar with how the leasing business having had some involvement in the construction equipment business. I hope you have some nice clients and everyone is making their payments to whoever you borrow the money from. And of course there’s a place for debt that’s how leasing companies functioned I thought. Where you and I part company is in believing we need to cutting (euphemistically consolidating) spending at present. We basically need short term fiscal and monetary stimulus and long term fiscal reform as you say. I think the prospects of double dip are exaggerated but it can’t be ruled out and any negative action of any kind right now is to be deplored. There was a good discussion on the Newshour last night between Rogoff, Krugman and a banker from JPM. Basically they all said this with Rogoff going further than anyone and saying the Fed needed to deal with debt hangovers and (to my astonishment) promote some inflation. Btw here’s a very intelligent appraisal of why the downgrade was iffy at the Harvard Business Review:

          http://blogs.hbr.org/cs/2011/08/does_standard_poors_deserve_a.html

    • jamesj

      “Democratic politicians screaming the Republicans want to take your Social Security and Tea Partiers screaming the liberal/commies want to bankrupt the country aren’t fixing the problem. They are the problem.”

      I totally agree that inflammatory populist rhetoric is bad for the country since it poisons the debate and prevents us from solving problems in a pragmatic way. But it is worth noting that dismantling Social Security is a core building block of the Republican party platform right now while I don’t think it is fair to say that the Democratic party establishment is full of “commies” or that they want to “bankrupt” the country.

      In other words, you draw a false equivalence. One of the two claims you bash is absolutely 100% factually accurate and is a statement about policy. The second of the two claims you bash is absolutely 100% factually false and is not a statement about any real policy position. How can we criticize both actions equally? Isn’t one of the two deserving of more criticism? Isn’t one of the two more intellectually pathetic?

      Note: I am no liberal, but I just don’t think you can objectively look at the two cases you listed and see them as equally problematic.

      • think4yourself

        I agree with you that the strident elements of the GOP want to roll back entitlements and a few want to end Social Security (but not too many and those have no power – medicare is a different story). The facts remain that the rhetoric impedes getting the results and the S&P downgrade was about their belief that the politics will stop policy makers from making good decisions.

        The GOP were the chief obstructionists here. But that’s because the pulled the trigger first. When Obama proposed the “grand bargain” most of the posters on here were of the opinion that it was a straw offer, that Obama did because he knew the GOP wouldn’t take it (and I guess they were right about the latter). I thought Obama was serious. Many have said that if the GOP did take it, the Liberals would have forced Obama to back away from it or find ways to gut it.

        I don’t watch Morning Joe, but yesterday there was an interview with the S&P CEO, it’s worth watching to understand their reasoning behind the downgrade.

        • ottovbvs

          “Many have said that if the GOP did take it, the Liberals would have forced Obama to back away from it or find ways to gut it.”

          How was the Robert Reich wing of the party going to do that? In fact I was one of those that said it was almost certainly a feint but I also said that if Republicans went for it then Obama would undoubtedly have made lemonade out of lemons and he certainly wouldn’t have been stopped by the far left and Bernie Sanders . Not that they were ever going for it of course. I was actually out of the country while all this drama was going on and missed a lot of the nuances but after getting back and taking a look at the ultimate deal I couldn’t understand why Democrats were whining so much (perhaps that’s their normal operating mode). In fact Obama got pretty much what he wanted and didn’t concede very much as these economically literate comments from conservatives and liberals (via the Economist) point out:

          http://www.economist.com/blogs/democracyinamerica/2011/08/deficit-reduction

        • think4yourself

          I rarely catch Newshour (like it when I do) but often watch Charlie Rose (only on FF will you have the readers of a supposedly GOP site watching those programs!) Of course, you’re right, we had lots of wild postulating but no real changes. In my view that’s the problem. I certainly differ with you on timing of cuts/tax increases. I think small cuts sooner (not today maybe but not waiting until 2014) would not hurt the economy. Even starting by letting the gov’t negotiate drug prices for example.

          If nothing gets done I hope that Obama lets the Bush tax cuts expire in their entirety including for those making less than $250K. However, my guess is that in pandering (maybe too strong a word) to the middle class, he’ll keep the cuts for everyone as happened last time.

          BTW, if you or any of your construction clients need equipment lease or finance, I’d be happy to help. I think we’re pretty good at what we do. Funding between $10,000 – 1,000,000. Mostly smaller size companies but we do have a smattering of Fortune 500′s in our client list. :)

  • Oldskool

    I go back and forth on the downgrade.

    You could say it was good for two reasons; the agency has little credibility which downgrades the actual downgrade (like getting a black eye from your little sister). And, it rightly makes one party look even uglier than they did during the debt deal.

  • TerryF98

    As it is congress (tea party) that fucked things up why recall them so the can fuck it up some more?

    • Smargalicious

      Terry, go back to bed.

      The Tea Party didn’t enact massive social welfare programs since 1964 that we’re now in debt up to our asses for. And what does Odumbo the Reparationist do?? Enact a massive Obamacare fiasco for the parasites.

      Go figure.

  • WestQuake

    Having dealt with U.S. ratings agencies up close and personal, I have little positive to say about them. Given the role assigned to them, however, complaining about the rating action last week is like the drunk driver complaining about the unreasonable actions taken by the police officer! Come to think of it, it’s exactly the same.

  • Graychin

    S&P has demonstrated repeatedly that it can’t find its butt, even using two hands.

    Why S.&P.’s Ratings Are Substandard and Porous:

    http://fivethirtyeight.blogs.nytimes.com/2011/08/08/why-s-p-s-ratings-are-substandard-and-porous/

  • Rob_654

    S&P couldn’t even do the math and had to be corrected by the Treasury – if they can’t do math, can they really do analysis.

    Let’s not forget that S&P gave Lehman Brothers a very good rating right up until the point the Lehman collapsed and went under.

  • ram6968

    mitch said this is going to happen everytime the debt ceiling comes up…S&P said, oh really?

  • Nanotek

    ottovbvs + 1

    If S & P was right, investors would not have migrated from stocks to treasury bonds en mass.

    the Great Republican Recession deepens due to the Repubican Tea Party fringers driving the bus.

  • Bagok

    Nate Silver had a great column yesterday. I won’t do it justice and it’s worth a read.
    S&P has such a poor predictive record that one would make more money by doing the opposite of what they suggest. Apparently most of their rating predictions do not come from any sort of statistical analysis, rather from a “Corruption Index”. The CI is a subjective analysis done by people who have little or no domain knowledge; have never been to the country they are rating, don’t speak the language. It’s like they read wikipedia and then decide the ratings from that.

  • Bagok

    and Graychin did a better job of it.

  • LFC

    With their track record, it looks like an S&P rating is becoming a contrarian indicator.

  • Slide

    So you believe the USA is less likely than the Isle of Mann to pay its bondholders?

    What rubbish. I didn’t think that S&P could have lower credibility than after the junk mortgage fiasco but they have manged to do so. Congrats S&P, well done.

  • ottovbvs

    “he’ll keep the cuts for everyone as happened last time.”

    think4yourself

    Nah… they are ALL going to expire as night follows day and that’s whether Obama wins or looses. The political dynamics make no other outcome likely. Given that leasing has to be a cyclical business tied to the apron strings of the wider economy I’m at something of a loss to understand your enthusiasm for early reduction of agg demand. Sorry can’t direct any business your way I’m fully and finally retired. Contractors are a lousy risk anyway… and none of the manufacturers are willing to take recourse! But I wish you well.