SP Lowers the U.S. Debt Rating
The Standards and Poor rating service has downgraded the U.S. Federal Government’s bonds to AA+ status. This action long overdue does not go far enough.
To understand the meaning of this, we should first understand the meaning of the S&P ratings.
The ratings indicate several things:
1) The likelihood of a default – the debtor failing to make interest payments owed to the people who purchased the bonds.
2) The likelihood that the bond holders will recover some of their losses after a default.
3) How quickly the debtor’s financial condition could deteriorate causing them to slide into default.
In the pdf explaining their rating system, S&P has a very interesting table showing the default rate associated with organizations based on their classification. As one would expect, in the past thirty years no AAA organization has defaulted, nor has any organization that is rated AA+.
In their press release explaining the downgrade, S&P makes the following points:
• The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
• More broadly, 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 challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
• The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case
• The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short ofwhat, in our view, would be necessary to stabilize the government’smedium-term debt dynamics.
• More broadly, the downgrade reflects our view that the effectiveness,stability, and predictability of American policy making and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned anegative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics anytime soon.
• The outlook on the long-term rating is negative. We could lower thelong-term rating to ‘AA’ within the next two years if we see that lessr eduction in spending than agreed to, higher interest rates, or newfiscal pressures during the period result in a higher general governmentdebt trajectory than we currently assume in our base case.
In essence, the S&P rating agency is implying that since the recent debate about raising the debt ceiling was immaturely handled, they are now more pessimistic than they were this spring. This strikes me as and excuse to give plausible deniability to the accusation that for years they have been rating the U.S. government much more favorably than is appropriate by any objective manner.
The fact is that over the past few decades, the U.S. government’s long-term fiscal condition has been steadily eroding, and the legislature has shown no willingness to seriously tackle the issue. Unsurprisingly any legislator who broaches the topic of reducing any of the major sources of spending, medicare, social security, millitary spending, corporate subsidies, etc risks being voted out of office by an electorate whipped into a frenzy about an attack on the elderly, the poor, our allies, etc.
The rating agencies, having been granted a monopoly on ratings by the U.S. government, have been loath to bite the hand that feeds them, to risk the wrath of the legislature by frankly describing the terrible financial outlook for the U.S. government. At this point the AAA rating has become a joke; there is no way that the U.S. government can pay back the loans. There is no ideological chasm between the Republicans and the Democrats. Both parties support massive welfare spending, high taxes, and massive plundering of the productive bits of the economy. I am increasingly of the opinion that the debt fight was a kabuki theatre engaged in by the Democrats and the Republican leadership in order to end the Tea Party threat to the metastasizing state. The Teaparty were the grownups announcing that the party has to stop, and the political parties’ leadership were the petulant teenagers plotting to keep things going a little longer.
At this point U.S. government bonds are a very bad thing to buy. The interest the U.S. government is offering is pathetically low. Inevitably, to attract buyers, the government will have to raise the interest rate. Once they do this, prices in the secondary market for the older low-yield bonds will collapse. The interest payments needed to service the outstanding debt will increase, and the U.S. government will be in even worse financial shape. It’s possible that the Federal Reserve will buy the bonds itself, using newly printed dollars, much like the central bank of Zimbabwe.
Unfortunately too many retirees have invested in U.S. government bonds, expecting that the income from the bonds would provide a reliable, dependable source of income. Either they will be screwed by the inevitable default, or they will find their income’s purchasing power destroyed by inflation.
