Within 24 hours, the Obama administration went from attacking
Standard & Poor’s first-ever downgrade of U.S. debt to almost
embracing it.
On the Friday night after it was issued, a Treasury
department official
made public a dispute about an error in which S&P had
overstated U.S. liabilities. S&P acknowledged the error, but
said it didn’t matter in the overall analysis.
Despite the administration’s earlier dismay, S&P’s
statement contained a lot of bones for Democrats to chew on. While
not recommending specific tax hikes, S&P
griped that “the majority of Republicans in Congress continue
to resist any measure that would raise revenues.” The report also
bemoaned “the prolonged controversy over raising the statutory debt
ceiling” and echoed media complaints about the supposed problem of
partisan gridlock and divided government.
No wonder that when the White House took over PR from
Treasury Department wonks, the government reactions became
political. “On Saturday,” the Associated Press
noted, “the administration appeared to soften its tone.” White
House press secretary Jay Carney said President Barack Obama
believes Washington “must do better” and set aside “our political
and ideological differences” in tackling the deficit. Senate
Majority Leader Harry Reid
gloated that the downgrade “reaffirmed the need for a balanced
approach,” meaning tax hikes. Then on Sunday, former Obama adviser
David Axelrod charged
that “this is essentially a tea party downgrade”
While there were some gripes on the Left that noted
(correctly) S&P’s dismal record at rating mortgage securities,
most progressive bloggers and pundits joined Axelrod in sticking to
their tried-and-true pastime of blaming the GOP and conservatives.
In the coming days, coming weeks, and probably the coming years,
look for liberal politicos and the media to use the downgrade and
threat of a further one as a bludgeon for higher taxes.
Advocates of limited government, while making the obvious
point that the downgrade is in large part a result of uncontrolled
federal spending that accelerated massively under the Obama
administration, must be careful to keep the focus on restoring
economic growth, rather than maintaining a subjective measure of
the nation’s credit rating. For S&P and the other big rating
agencies, long beneficiaries and enablers of big government
policies, are experiencing somewhat of a market downgrade
themselves.
Given the alternative of Eurozone debt, the doom and gloom
scenarios of a U.S. downgrade may be vastly overstated. And even if
a lower rating does lower demand for U.S. Treasuries, this may have
with the benefit of more investment in the private, as opposed to
the government, sector.
Indeed, come Monday, we may find that the markets had
already factored in a potential S&P downgrade. S&P was
actually a Johnny-come-lately at marking down U.S. debt, as two
upstart credit rating agencies, Egan-Jones Rating Co. and Weiss
Ratings, had already done so.
Unlike S&P, these firms made clear that their ratings
were about long-term prospects, rather than the debt ceiling fight,
and emphasized spending over taxes. When Egan-Jones, widely
respected for its early downgrades of Bear Stearns and Lehman
Brothers , changed its rating of U.S debt from AAA to AA+ on July
16, it explained: “The major factor driving credit quality is the
relatively high level of debt and the difficulty in significantly
cutting spending. We are taking a negative action not based on the
delay in raising the debt ceiling but rather our concern about the
high level of debt to GDP.”
Similarly, Weiss, which lowered its rating in April from C
to C-, offered this explanation: “Our downgrade today is not
contingent on the outcome of the debt-ceiling debate.”
By contrast, a closer look at the S&P downgrade shows
that the firm may have been motivated by its desire to remain a
political player. Fox Business correspondent Charlie Gasparino
argued on-air Saturday that the firm “boxed itself in” by demanding
$4 trillion in cuts and encouraging tax hikes. When Congress passed
cuts of less than this amount in a package that contained no tax
hikes, S&P likely felt that it had to make good on its threat
but do so in a way that curried some favor with the administration
in power.
The ratings cartel of S&P, Moody’s, and Fitch was
created by decades of government regulation blocking meaningful
competition. In 1975, the Securities and Exchange Commission (SEC)
created the designation of “nationally recognized statistical
rating organization” (NRSRO) for credit rating firms. Regulatory
agencies soon began requiring that banks, brokerage firms,
pensions, and insurance companies carry mandated levels of
securities rated AAA from an SEC-approved NRSRO.
From the 1990s until 2003, only the “Big 3” had been
approved by the SEC to be NRSROs. And when these firms would rate a
new security as AAA, financial firms would rush to buy it to
satisfy their regulatory capital requirements. This is what helped
created the bubble in AAA-rated mortgage-backed
securities.
But slowly and surely, the state-backed financial ratings
cartel began to crack. Prodded to increase competition by the
bipartisan Credit Rating Agency Reform Act of 2006, there are now
ten firms approved by the SEC to be NRSROs, including Egan-Jones.
And over the weekend, financial regulators prudently waived the
NRSRO requirement so that financial firms holding U.S Treasuries
would not have to substitute “safer” bonds of AAA-rated countries
such as France to satisfy their regulatory capital
requirements.
These developments augur less disastrous results from the
downgrade than predicted, and even some positive effects. Interest
rates probably won’t rise much more than they did when Treasuries
were downgraded by Weiss and Egan-Jones. The main reason is that,
given events in the European Union, there isn’t a safer Treasury
bond than the American one to which a “flight to safety” would
occur.
As noted in a June 22
analysis by the Financial Times , “With the eurozone
engulfed in a debt crisis and emerging market economies, such as
China, years away from becoming legitimate global financial
entities, investors insist there is really no alternative to the
U.S. at the present time.” As Jim Paulsen, chief investment
strategist at Wells Capital Management, told the paper, “A
downgrade for the U.S. would mean the new triple A is double
A.”
But even if there were slightly higher interest rates and
slightly less demand for U.S. bonds as a result of the downgrade,
would that really be so bad? After all, this would mean fewer
inflationary pressures and higher costs for the government to
borrow money to create new bureaucracies.
A more honest evaluation of the risks of government
securities also means a more even playing field for entrepreneurs
to raise capital. The AAA rating for U.S. and other government
securities has given sovereign debt an advantage over private debt.
Given the profligate behavior of many of the world’s governments,
this advantage was often undeserved. If the AAA were gone for the
U.S. and European countries, “investors seeking a fixed and totally
safe return would no longer look towards governments, but to the
most stable and profitable private companies,” argues
financial analyst Martin Hutchinson at PrudentBear.com
In the meantime, the U.S. should slash spending, taxes,
and regulation. Not for the purpose of restoring S&P’s AAA
rating, but to restore the quadruple-A capitalist system that
allowed investors and entrepreneurs to propel America to economic
greatness.
Prediction: Defying all conventional “wisdom,” the U.S.
stock market will be up for the day on Monday. Maybe by 10 points,
or maybe 100, but it will end the day in positive
territory.
