Just the Facts: S&P's $2 Trillion Mistake

[Gumby]

An official rebuttal from the US Treasury:

Treasury.gov: Just the Facts: S&P's $2 Trillion Mistake

[WildAboutHarry]

Any bets on how soon next week S&P restores the AAA?

[Gumby]

S&P claims that it won't be any time soon. Truthfully it's all a bit ridiculous considering they were the people who brought us AAA rated mortgage-backed securities that led to our downfall.

[WildAboutHarry]

I have to think the political pressure to reconsider is going to be tremendous, and the $2 Trillion error gives S&P the option to reverse course and say "After further review..."

Was any reason given for the Friday close of business timing of the announcement?  Maximum time for weekend rumination?  Maximum effect on Monday's opening?

[MediumTex]

Talk about a comedy of errors.

It's like the blind leading the stupid.

[smurff]

The world of finance (including major corporations, like Berkshire-Hathaway) like to make major market-moving announcements on Friday evening (or at the end of the last trading day before a holiday weekend), after the markets have closed.  It gives the bankers at the Fed and hedge fund analysts the weekend to come up with their new trading strategies and tactics, which will probably be devised and revised (over boxes of pizza and Chinese food) several times before the market reopens on Monday morning.  It gives algorithm developers  time to tweak the HFT programs with new info.  It gives time for cooling off, for discussion and tea-leaf reading, so that individuals and corporations who make investment decisions have time to do so without the influence of panic.

If they had made such an announcement any time Mon-Thu, or Friday morning, the stock and bond markets likely would have crashed that day or the next.  They may still tank on Monday, but probably not as much had the announcement been made Friday morning.

Remember in October 2008, when the Congress was unsettled about approving TARP funds and other increases in debt?  (You know, when the Treasury Secretary Paulsen gave them a typed sheet of paper with his demands, including an outrageous sentence that essentially made him an unchallengeable dictator?) Back then, the Congress would vote during a weekday, then the DJIA would lose 400 points as the "no" vote tallies scrolled on the screen--and another 700 points the next morning.

[Reub]

Does the U.S. deserve a AAA rating?

[MediumTex]

Does the U.S. deserve a AAA rating?

Has it ever defaulted on an obligation?

Is it politically stable?

Does it have mechanisms for protecting property and contract rights?

Is there a history of interest rate volatility in its sovereign debt?

It may be that we live in a world where there are no AAA credit risks, but to downgrade the U.S. on a sloppy data set at this time seems like a strange thing to do.

Maybe if the ratings agencies had a better track record in recent years I would have more respect for this move.

[doodle]

Whether it is justified or not, I ultimately think it is for the best. Hopefully, it will inspire some more genuine solutions from Congress regarding our long term debt and deficit issues. Maybe, we don't deserve a downgrade at the moment, but our current trajectory is certainly unsustainable and the quicker we rectify the structural imbalances in the economy, the better.

[Storm]

Maybe we should just do what Spain did and have police raid the offices of S&P...  Nothing says "don't downgrade me, bro!" like a police warrant and seizure of all computers and files. 

[WildAboutHarry]

Nothing says "don't downgrade me, bro!" like a police warrant and seizure of all computers and files.

A less strong-armed approach (and ultimately much more terrifying to the targets) is for the federal government to simply begin regulation (or increase regulation?) of the credit rating companies.

[Jan Van]

Nothing says "don't downgrade me, bro!" like a police warrant and seizure of all computers and files.

A less strong-armed approach (and ultimately much more terrifying to the targets) is for the federal government to simply begin regulation (or increase regulation?) of the credit rating companies.

Isn't that what this is all about anyway?

Matt Stoller: Standard & Poor’s Predatory Policy Agenda

[Gumby]

Maybe, we don't deserve a downgrade at the moment, but our current trajectory is certainly unsustainable

Not sure how you can say that "maybe we don't deserve a downgrade" and that our "current trajectory is certainly unsustainable" in the same breath. If the US government technically can't run out of money, then who are you (or S&P) to judge what is "certainly" unsustainable?

Think of it this way...

Nobody believes that the US government can run out of money, as we have no reserve constraints. This is not debated. The question is whether or not Congress is willing to pay a parabolic deficit in the future. S&P says that it doesn't see that happening. And truthfully, I agree that Congress is unlikely to want to pay for all of the unfunded liabilities. But, that means that S&P is basically trying to predict the US government's tolerance for increasing the deficit — not its fiscal ability to increase the deficit. That's something a rating agency has never done before. It's unprecedented.

Typically a rating agency is only supposed to deal with fiscal matters. In this case, they've laid out a political agenda that they want the country to follow. The criticism is that they acting less like a rating agency and more like a lobbying firm that happens to give out ratings.

(And jmourik's link, above, shows a disturbing pattern of this behavior)

[MediumTex]

Great post Gumby.

[doodle]

Gumby,

We were very close to running out of money. Congress was a hairs breadth away from not raising the debt ceiling. S&P simply sees the political infighting as a risk to the US's continued willingness to make the political choices that will honor all of our of the governments obligations and promises.

Congress is unlikely to want to pay for all of the unfunded liabilities

Wouldn't this count as a default? Promises made that are not honored.

If the US government technically can't run out of money, then who are you (or S&P) to judge what is "certainly" unsustainable?

Just cause our government has the ability to print money doesn't mean that it deserves a AAA credit rating. Sure, its debts are denominated in dollars, but there is no conceivable way to honor them without simply running the printing presses. I guess S&P views debt monetization as a form of default.

[Gumby]

We were very close to running out of money. Congress was a hairs breadth away from not raising the debt ceiling. S&P simply sees the political infighting as a risk to the US's continued willingness to make the political choices that will honor all of our of the governments obligations and promises.

Yes. We're saying the same thing. Except that I'm saying that rating agencies aren't supposed to rate future political emotions.

Congress is unlikely to want to pay for all of the unfunded liabilities

Wouldn't this count as a default? Promises made that are not honored.

Sure it's a default on entitlements. But, cutting a program is not a default on Treasury Bonds. Why should S&P care what programs are cut five years from now? S&P is supposed to be rating our debt, not our programs. That's what lobbyists do.

If the US government technically can't run out of money, then who are you (or S&P) to judge what is "certainly" unsustainable?

Just cause our government has the ability to print money doesn't mean that it deserves a AAA credit rating. Sure, its debts are denominated in dollars, but there is no conceivable way to honor them without simply running the printing presses. I guess S&P views debt monetization as a form of default.

Wrong. That's exactly why they deserve a AAA rating. There's no credit risk! Ask Warren Buffet. Ask anyone who knows how a bill is paid. On top of that, there is a huge demand for Treasury Bonds. Treasury Bonds are still the world's safest investment.

The Treasury showed S&P actual hard data how the government was going to fund the foreseeable future — using Treasury Bond issuance alone. S&P ignored the data, laid out an agenda, and based its rating solely on the potential for political infighting in the future. That's never been done before. How does a rating agency get to decide what emotions Congress may have in the future? Please don't tell me that a rating agency should be judging future political emotions now. That's just crazy.

[doodle]

Gumby,

So, are you making the argument that US treasury bonds deserve a AAA credit rating no matter what the fiscal balance sheet of our government looks like? What about a scenario where interest on debt consumes 100% of govt tax revenues? Would that justify a credit downgrade?

Why was Japan's debt downgraded? Doesn't their central bank have monetary sovereignty?

I think it is also important to note that S&P didn't downgrade our short term debt....only our long term debt. From my perspective this is justified given the fact that the government infighting has not allowed leaders to put together a reasonable plan showing how they will address long term fiscal debts and deficits.  While we could conceivably honor all of them by firing up the printing presses, debt monetization is not something that a responsible AAA rated country engages in.

Why should S&P care what programs are cut five years from now? S&P is supposed to be rating our debt

The stability of our debt is tied to the stability of our government and economy. The stability of our government and economy are tied to our ability to maintain the promises that 75 million retiring seniors are depending on. I think the risk of long term instability has increased.

On top of that, there is a huge demand for Treasury Bonds.

As there was for Mortgage Backed Securities before the crash. Demand for something doesn't determine its credit worthiness.

[Gumby]

Gumby,

So, are you making the argument that US treasury bonds deserve a AAA credit rating no matter what the fiscal balance sheet of our government looks like?

No. I'm saying that as long as the government has the ability to pay its bills, and there is nothing better out there (i.e. demand for Treasuries is high), it deserves a AAA credit rating.

Why was Japan's debt downgraded? Doesn't their central bank have monetary sovereignty?

Japanese debt was (supposedly) downgraded for quantifiable reasons: Large debt pressure, low interest rates and higher demand for "safer" Treasuries.

When S&P downgraded US Debt, there was no legitimate reason. Go ahead... find me a quantifiable fiscal reason why they downgraded US debt. You can't find one. Their initial math was wrong, and they've presented no real evidence why their won't be demand for US debt. They've presented no real evidence why the bonds won't be purchased. They've only predicted that the political infighting will cause debt-ceiling problems. Since when are rating companies in the business of predicting political rhetoric? Never.

I think it is also important to note that S&P didn't downgrade our short term debt....only our long term debt. From my perspective this is justified given the fact that the government has not put together a reasonable plan showing how they will address long term fiscal debts and deficits. While we could conceivably honor all of them by firing up the printing presses, debt monetization is not something that a responsible AAA rated country engages in.

The Treasury presented a plan that does not involve firing up the printing presses. Show me where in the Treasury's plan they are monetizing the debt.

Why should S&P care what programs are cut five years from now? S&P is supposed to be rating our debt

The stability of our debt is tied to the stability of our government and economy. The stability of our government and economy are tied to our ability to maintain the promises that 75 million retiring seniors are depending on. I think the risk of long term instability has increased.

That's not what S&P said. And now you're just playing politics. Rating agencies aren't supposed to play politics. They are supposed to stick to fiscal matters — not predicting political matters.

On top of that, there is a huge demand for Treasury Bonds.

As there was for Mortgage Backed Securities before the crash. Demand for something doesn't determine its credit worthiness.

Not sure what you're talking about. Mortgage Backed Securities have never had the demand that Treasuries do. Not even close. Treasuries are engineered to represent the safest investment in the world and there is a huge demand for them.

[Gumby]

Doodle, ultimately the only reason why you like the downgrade is because you agree with the politics behind their decision. That's your bias. Fine.

But, what you're not realizing is that predicting future political decisions isn't supposed to be — and never has been — part of their rating decisions.

They've effectively turned into a corrupt political lobbying machine, with an agenda.

How do you not see the problem with that?

[Reub]

Have you seen Zimbabwe's new 100 trillion dollar bill?
They can print more money just like we can.

http://media.photobucket.com/image/zimb ... il.jpg?o=1

[doodle]

Reub,

I have a fifty trillion bill in my wallet actually.

Gumby,

I don't see why S&P shouldnt take politics into consideration when making a decision to downgrade. It is after all the politicians that control the purse strings. After the recent showdown, it isn't necessarily clear to what degree some of our politicians are willing to go to push their agenda. That in my mind adds a slightly larger degree of risk to our debt. What will happen in two years time when we hit the debt ceiling again? The debate is certain to contain a lot of fireworks and potential for another hostage type situation.

From a fiscal standpoint it is quite evident that our government is extremely cash flow negative at the moment with a huge amount of debt and future unpaid liabilities on the balance sheet. Printing money does not offer any solution to these issues as monetization is equivalent to default.

These two factors combined, in my mind, do not equate with a triple AAA rating. But again, everyone is free to vote in the market.

[Jan Van]

S&P decision is irrelevant
http://bilbo.economicoutlook.net/blog/?p=15580

[doodle]

From the article Jmourik posted:

The national government which issues the Australian dollar will always be able to fund whatever legal Australian dollar pension entitlements are in place at any time. What they cannot necessarily guarantee is the on-going real continuity of those entitlements – that is, the quantity of real resources that the pension cheques can buy. That depends on availability of real resources and the productivity of the workforce.

I don't think many Americans realize that just because the American government can pay them the quantity of entitlement dollars they were promised, it doesn't mean those additional dollars will buy a larger part of the total American economy.

If Simpleland's economy produces one pizza, and there are 10 dollars in a two person economy, then 5 dollars should buy each person half a pizza. If the government just doubles the money it gives to each person, then it will just double the price of half a pizza.

I guess the choice that the government has to make is do they prefer to default on obligations to seniors, or suffer the inflationary effects of printing money to meet the promises they made?

If they choose the second option, there is significant danger to long term bond holders.

[doodle]

Reading Jmourik's article just confuses me with more MMT. There seems to be some disconnect between money and the real economy in MMT that I cannot bridge in my mind.

If the real economy produces one pizza and there are four people, then irrespective of the money in the system, an equitable division of the economy's output would allow each person to consume 1/4 of a pizza. If the money supply of the economy was set at $10, then a quarter pizza would cost 2.5 dollars.

Now, when the government comes in and makes future promises that each of the 4 people is entitled to 1/2 a pizza, it doesn't change the fact that the economy can still only produce 1 pizza. Even if the government doubles the money supply so that each person has enough at previous prices to afford 1/2 a pizza, the economy still only produces one pizza.

This is what I see as the fundamental "debt" problem. Governments have promised people half a pizza when the economy can only deliver 1/4. In order to not default on promises, the government will honor their monetary obligations to citizens, who will all go forward expecting to buy half a pizza. They will soon realize that it is impossible to divide one pizza in half between 4 people. This in turn leads to inflation. Inflation will lead to bondholders demanding higher interest on savings which will lead to increased interest rate payments as a percentage of govt tax revenues.

If the situation continues, interest payments on debt exceed govt tax revenues. At that point govt is forced to monetize debt which has further negative consequences on price stability.

I know there must be an error in my thinking somewhere, but I cannot seem to shake this model of how things work.

[stone]

Doodle the "more money gives inflation" equation totally depends on the money being spent rather than saved. Warren Buffet is not about to order 40 billion pizzas. If he did, then pizza prices would go up but he isn't going to. The key thing is that all the extra money is given to people who save it. That is why Japan does not have inflation and also why the Fed pumping up asset prices does not stimulate the real economy. What printing money so as to finance cutting taxes for the rich does do is create an ever larger pool of money searching for something to do. The only way that pool of money ever can diminish is by taxation OR by primary dealers buying treasuries. EVERYTHING else just passes the money around. I think that is why demand for treasuries can be taken for granted at present.