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MANY US commentators are pretty sceptical about rating agency Standard & Poor’s (S&P's) lowering of the outlook for US debt to negative. After all, the ratings agencies helped create the financial crisis by rating junk mortgages AAA. Now, suddenly, they want to sing a conservative tune.
In a discussion on the New York Times website, economist Barry Ritholtz from the online quantitative research firm Fusion IQ, writes: “I have stopped paying attention to anything that S&P says or does.
"Its performance over the past decade has revealed it to be incompetent and corrupt – it sold its AAA ratings to the highest bidder. It is the broker who lost all your money, the girlfriend who cheated on you, the partner who stole from you. Since the portfolios we run never rely on its judgment or analysis, we simply do not care what it says about credit ratings.”
L Randall Wray, professor of economics at the University of Missouri-Kansas City, says: “Yes, the raters who blessed virtually every toxic waste sub-prime security they saw with AAA ratings now see problems with sovereign government debt.”
Still, the markets took notice, fearing a devaluation in the dollar and a spike in US government debt interest rates. Such a spike in interest rates would affect consumers and businesses too. US mortgage rates are linked to long-term government rates, and would rise if there was a shock to the market.
It’s important to note that S&P hasn’t actually downgraded US debt; it has merely said the outlook is negative. Wray writes that a decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from government. The raters backtracked and said they weren’t rating Japan’s ability to pay, but rather the prospects for inflation and currency depreciation.
After 10 more years of running deficits, Japan’s debt as a percentage of gross domestic product is 200%. Yet it borrows at nearly zero interest rates, makes every payment that comes due, the yen is strong and deflation reigns.
“While I certainly hope we do not repeat Japan’s economic experience of the past two decades, I think the impact of downgrades by raters of US sovereign debt will have a similar impact here: zip,” Wray says.
New York Times columnist Paul Krugman points out that when S&P downgraded Japan in 2002, Japanese bonds became known as the “trade of death”, because people kept betting on an interest rate rise, and it kept not happening. “So, no big deal,” concludes Krugman.
Krugman does, however, note that: “At first read, what it (S&P) says doesn’t seem too silly: it lays stress, rightly, on political gridlock. The point should be that the US is perfectly capable both of running large deficits now and getting its fiscal house in order over time; but not if the parties cannot agree on any kind of solution. ”
That is what some commentators say is the key issue highlighted by S&P - the big divide between the Democratic Party and the Republican Party on how to get the deficit down.
“More than two years after the beginning of the recent crisis, US policymakers have still not agreed on how to reverse recent fiscal deterioration or address longer-term fiscal pressures,” says Nikola Swann, a credit analyst at S&P. The company says there was a one in three chance that it could lower its long-term rating on the US in two years.
Despite what economists are saying in the aftermath of the announcement, the belief that the cost of borrowing will rise if the US is downgraded sent stock markets reeling. Interestingly, however, the market for Treasury bonds didn’t react dramatically. The yield on the benchmark 10-year Treasury Bond initially spiked up to 3.45%, but then ended Monday at 3.37%, down from 3.41% on Friday.
Good starting point
Both President Barack Obama and Republic lawmakers have suggested plans to cut the federal deficit by at least $4 trillion over the next 10 to 12 years, but by different methods.
The Times reports that Obama plans to take his message on the road this week, travelling to the West Coast to promote his proposal, which combines spending cuts and revenue increases. Bloomberg reports that the president proposes higher taxes for the rich, while keeping programmes for the poor and elderly largely intact.
Republicans reacted angrily to Obama’s proposal to raise taxes. The Republican plan includes no tax increases, while a quarter of Obama’s $4 trillion in deficit reduction comes from higher taxes.
The Republican blueprint championed by Representative Paul Ryan, chairperson of the House of Representatives’ budget committee, includes cutting non-military spending, and a politically charged proposal to fundamentally reconfigure Medicare, the state-backed medical aid for the elderly.
S&P doesn’t take sides on any of the political proposals, saying that they are a good starting point. But it cautions that “we see the path to agreement as challenging because the gap between the parties remains wide.”
However cynical one wants to be about ratings agencies, the S&P move to downgrade the outlook for US debt is a wake-up call for politicians to stop pie-in-the-sky proposals and to sit down and hammer out a genuine agreement on how to cut the US deficit.
- Fin24
In a discussion on the New York Times website, economist Barry Ritholtz from the online quantitative research firm Fusion IQ, writes: “I have stopped paying attention to anything that S&P says or does.
"Its performance over the past decade has revealed it to be incompetent and corrupt – it sold its AAA ratings to the highest bidder. It is the broker who lost all your money, the girlfriend who cheated on you, the partner who stole from you. Since the portfolios we run never rely on its judgment or analysis, we simply do not care what it says about credit ratings.”
L Randall Wray, professor of economics at the University of Missouri-Kansas City, says: “Yes, the raters who blessed virtually every toxic waste sub-prime security they saw with AAA ratings now see problems with sovereign government debt.”
Still, the markets took notice, fearing a devaluation in the dollar and a spike in US government debt interest rates. Such a spike in interest rates would affect consumers and businesses too. US mortgage rates are linked to long-term government rates, and would rise if there was a shock to the market.
It’s important to note that S&P hasn’t actually downgraded US debt; it has merely said the outlook is negative. Wray writes that a decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from government. The raters backtracked and said they weren’t rating Japan’s ability to pay, but rather the prospects for inflation and currency depreciation.
After 10 more years of running deficits, Japan’s debt as a percentage of gross domestic product is 200%. Yet it borrows at nearly zero interest rates, makes every payment that comes due, the yen is strong and deflation reigns.
“While I certainly hope we do not repeat Japan’s economic experience of the past two decades, I think the impact of downgrades by raters of US sovereign debt will have a similar impact here: zip,” Wray says.
New York Times columnist Paul Krugman points out that when S&P downgraded Japan in 2002, Japanese bonds became known as the “trade of death”, because people kept betting on an interest rate rise, and it kept not happening. “So, no big deal,” concludes Krugman.
Krugman does, however, note that: “At first read, what it (S&P) says doesn’t seem too silly: it lays stress, rightly, on political gridlock. The point should be that the US is perfectly capable both of running large deficits now and getting its fiscal house in order over time; but not if the parties cannot agree on any kind of solution. ”
That is what some commentators say is the key issue highlighted by S&P - the big divide between the Democratic Party and the Republican Party on how to get the deficit down.
“More than two years after the beginning of the recent crisis, US policymakers have still not agreed on how to reverse recent fiscal deterioration or address longer-term fiscal pressures,” says Nikola Swann, a credit analyst at S&P. The company says there was a one in three chance that it could lower its long-term rating on the US in two years.
Despite what economists are saying in the aftermath of the announcement, the belief that the cost of borrowing will rise if the US is downgraded sent stock markets reeling. Interestingly, however, the market for Treasury bonds didn’t react dramatically. The yield on the benchmark 10-year Treasury Bond initially spiked up to 3.45%, but then ended Monday at 3.37%, down from 3.41% on Friday.
Good starting point
Both President Barack Obama and Republic lawmakers have suggested plans to cut the federal deficit by at least $4 trillion over the next 10 to 12 years, but by different methods.
The Times reports that Obama plans to take his message on the road this week, travelling to the West Coast to promote his proposal, which combines spending cuts and revenue increases. Bloomberg reports that the president proposes higher taxes for the rich, while keeping programmes for the poor and elderly largely intact.
Republicans reacted angrily to Obama’s proposal to raise taxes. The Republican plan includes no tax increases, while a quarter of Obama’s $4 trillion in deficit reduction comes from higher taxes.
The Republican blueprint championed by Representative Paul Ryan, chairperson of the House of Representatives’ budget committee, includes cutting non-military spending, and a politically charged proposal to fundamentally reconfigure Medicare, the state-backed medical aid for the elderly.
S&P doesn’t take sides on any of the political proposals, saying that they are a good starting point. But it cautions that “we see the path to agreement as challenging because the gap between the parties remains wide.”
However cynical one wants to be about ratings agencies, the S&P move to downgrade the outlook for US debt is a wake-up call for politicians to stop pie-in-the-sky proposals and to sit down and hammer out a genuine agreement on how to cut the US deficit.
- Fin24
