Standard & Poor’s Downgrade Raises One Legitimate Issue
Standard & Poor’s downgrade of the US credit rating got off to a clownish start with its stupid math error. Apparently the people who rate sovereign nations are no better than the people who rated real estate mortgage-backed securities. Even so, it looks like S&P got one thing right.
S&P publishes the methodology for its sovereign ratings here (the link to the .pdf is under the heading The Basics of Sovereign Ratings.) Under the heading “Scope”, S&P explains that the purpose of the ratings is to assess “…sovereign’s ability and willingness to service financial obligations to nonofficial, in other words commercial, creditors.” That simple idea explains why people blame the Tea Party wreckers: they were willing to make it impossible for the US to pay its commercial creditors, not bonds, perhaps, but its general obligations to suppliers of goods and services. There are five factors to the rating:
· Institutional effectiveness and political risks, reflected in the political score.
· Economic structure and growth prospects, reflected in the economic score.
· External liquidity and international investment position, reflected in the external score.
· Fiscal performance and flexibility, as well as debt burden, reflected in the fiscal score.
· Monetary flexibility, reflected in the monetary score.
S&P issued a press release explaining its actions, which you can find here. It says that the debt ceiling deal is insufficient to “stabilize the government’s medium-term debt dynamics.” The rest of it is political: S&P thinks that the gulf between the parties is too wide and cannot be bridged in a way that will lead to balanced growth. Their view of the other three key points is unchanged.
John Bellows, an acting assistant secretary in the Treasury, spotted a stupid mistake in S&Ps calculations of projected debt growth. Bellows provides a crystal clear explanation of the error here. It came from applying the changes made by the debt ceiling deal to the wrong baseline, one leading to a higher estimate of long-term growth of debt. Bellows explains:
In fact, S&P’s $2 trillion mistake led to a very misleading picture of debt sustainability – the foundation for their initial judgment. This mistake undermined the economic justification for S&P’s credit rating decision. Yet after acknowledging their mistake, S&P simply removed a prominent discussion of the economic justification from their document.
Bellows is right. After making a stupid mistake, instead of going through its procedures, and rechecking its math, S&P left a couple of unsupported sentences about the trend of debt growth, and relied primarily on the political war between the parties. S&P points to the use of the debt ceiling as a bargaining chip as one factor. Congress was not able to agree on cuts to discretionary spending, and punted to the Super Congress. They couldn’t agree on increasing taxes or entitlement cuts. That’s fairly accurate, as far as it goes.
This outcome turns on their application of paragraphs 36-41 of their methodology. Paragraph 37 says that the primary consideration is “The effectiveness, stability, and predictability of the sovereign’s policymaking and political institutions…” The other factors in paragraph 37 are unchanged. This table explains the factors for the top three scores.
Paragraph 40 lays out the underlying issues:
The criteria analyze the effectiveness, stability, and predictability of policymaking and institutions based on:
· The track record of a sovereign in managing past political, economic, and financial crises; maintaining prudent policy-making in good times; and delivering balanced economic growth.
· A sovereign’s ability and willingness to implement reforms to address fiscal challenges, such as health care or pensions, to ensure sustainable public finances over the long term.
· The predictability in the overall policy framework and developments that may affect policy responses to future crisis or lead to significant policy shifts.
· Actual or potential challenges to political institutions, possibly involving domestic conflict, from popular demands for increased political or economic participation, or from significant challenges to the legitimacy of institutions on ethnic, religious, or political grounds.
The debt ceiling struggle reflects on two of these, the willingness to address long-term fiscal challenges, meaning Social Security and Medicare, and the predictability of the overall policy framework.
Social Security is a problem for the future. Health care costs can only be contained by fundamental changes in the way we provide it. The idea that we would lose our AAA rating because we couldn’t fix those problems in a few days or weeks is just as stupid as the math error.
It is true that our policy frameworks are under stress, and are less predictable. That is the natural outcome of the stresses caused by the Great Crash and the Lesser Depression. Congress is populated by old people fighting old wars. Administrative agencies like the EPA and the SEC are hamstrung by unprincipled decisions of the Supreme Court and even less accountable lobbyists worming into the system and sucking the vitality out of enforcers and regulators. Think tanks, universities and other institutions that used to provide stability have been corroded by the concerted efforts of rich people operating through their corporations, lobbyists and massive piles of cash. Society is wracked by the stresses of unemployment, stagnant incomes and a media that denies reality in favor of reality TV. Economic forces are building, putting pressures on all aspects of our weakened institutions, but our political structures no longer permit them to work out through gradual adjustments.
The President has tried the old politics of bipartisan efforts to address our fundamental problems. He failed, but not for want of trying, not for want of willingness to bargain away everything I hold dear about the nation. Our problems can’t be solved through thoughtful analysis and accommodation to reality, or by reasoned compromise.
Maybe S&P is right to fear a tectonic adjustment.