I’m told that the Fed may not have the authority to allow Treasury to overdraw on their account. Besides, the rating agencies would be justified in downgrading US debt when the Treasury is overdrawn. And the White House – and Congress, potentially – fear downgrade more than default.

What the rating agencies would not be justified in doing is picking a deficit reduction target and punishing the United States for not meeting it. That is not a dispassionate analysis of how markets will react. That’s an aggressive activist position designed to force austerity. According to thereisnospoon, this is being done to force a repeal of the Bush tax cuts. I’m really not seeing that, but he cites Fred Bauer:

However, digging into the S&P report reveals some details that might be more problematic for many seeming “deficit hawks.” Though this report does suggest that $4 trillion in cuts/increased revenue over the next ten years would be enough to keep an AAA rating, it also says that its baseline for savings assumes the expiration of the Bush tax cuts in 2012. Will many of these “deficit hawks” abandon those tax cuts in order to appease S&P and keep an AAA rating?

Now wait a second. Repealing the Bush tax cuts WOULD save $4 trillion. So if I’m getting this right, S&P is endorsing the “do nothing” approach of allowing those tax cuts to expire.

But that means that S&P has nothing to worry about. We’re on that trajectory. If they downgrade the credit rating based on a too-small deficit reduction plan, they’re not taking into account the imminent demise of the Bush tax cuts in 2012. Under this standard, they should not touch the credit rating until that time.

Which is why I don’t really believe this reading. Because S&P put a 90-day watch on the credit rating. They’re not going to wait and see if the Bush tax cuts expire. So it’s a red herring. I prefer spoon’s analysis:

Bauer lists several other more subtle reasons that S&P is out to lunch on their analysis and prognostication, and Kevin Drum points out that there’s no real reason that the market should be getting nervous about buying treasuries, anyway. But we don’t even need to go there. These people are idiots. They got so burned by their total failure to rate mortgage-backed securities and credit default swaps as the dog vomit they were, that they’re desperate to overcorrect by downgrading other bonds wherever they can. As they say, never chalk up to malevolence what can best be explained by incompetence.

Reading stuff like this brings to mind the points made by Matt Taibbi and Michael Lewis that the ratings agencies are basically chock full of lesser lights who couldn’t make it actually playing with the big boys on Wall St. And yet they seem to have the duly elected government of the world’s largest economy dangling by a string.

You can hardly blame S&P for seeing dysfunction in the American political system. But you can blame them for being completely dysfunctional themselves.

David Dayen

David Dayen