U.S. Credit Rating Downgraded: Economists Comment on S&P Error

It appears Standard & Poor’s credit agency downgraded the U.S. credit rating using an incorrect budget baseline and now analysts are questioning why they, the government or the American people should listen to an agency that is apparently incompetent. The mistake hearkens back to S&P’s failed decision to adjust its outlook or rating when the U.S. entered into the recession, and not giving a fair evaluation to investment products and policies that endangered the economy. The error, which misjudged the baseline for rating by $2 trillion, is seen by most as too big to ignore when evaluating the agency. For more on this continue reading the following article from Economist’s View.

I was asked to comment on S&P's downgrade of long-term US debt:

The Consequences of the S&P Downgrade

As I explain, I don't expect much in the way of market or interest rate reaction to the downgrade. Also, I didn't mention this, but S&P's demonstrated incompetence on matters such as choosing the right baseline is another reason to ignore their pronouncement:

I Heard It Through The Baseline, by Paul Krugman: Oh, my. Treasury has a fact sheet explaining that $2 trillion error by S&P; it may sound technical, but to anyone who follows budget issues, it’s a doozy.

When the Congressional Budget Office “scores” policies, it does so relative to a “baseline”... But S&P initially assumed that the debt deal was subtracting off a quite different baseline.

The point here is not so much the $2 trillion, which makes very little difference to real US fiscal prospects; it’s the fact that S&P stands revealed as not understanding basic analysis of budget estimates. I mean, I don’t think I would have made that mistake; real budget experts, like the people at the Center on Budget and Policy Priorities, certainly wouldn’t have.

So what we just saw was amateur hour. And these people are pronouncing on US credit-worthiness?

Donald Marron:

S&P's 2 Trillion Dollar Error: ...The error is understandable but remarkably sloppy for such an important analysis.

The source of the error is painfully familiar to anyone who deals with U.S. budget projections. S&P’s analysts didn’t use the right measuring stick — i.e., the right budget baseline — when analyzing the effects of the recently-enacted Budget Control Act.

In one sense, it’s easy to see how this error happened. Budget discussions are now hopelessly confused by a profusion of different baseline projections of what spending and revenues will look like in the future. ...

But it’s still remarkably sloppy. Budget experts are well-aware of the problem of multiple baselines. Indeed, we all pepper our conversations and analysis with the question “what baseline are you using?” It’s stunning that S&P didn’t have multiple analysts asking the same question to make sure their original numbers were right.

He adds that:

It’s own revised calculations show net general government debt hitting 85% of gross domestic product in 2021 instead of 93%. That’s a big difference. ... S&P was too dismissive in its clarification.

Experts wouldn't have made this mistake. So why is anyone listening to S&P?

This article was republished with permission from The Economist's View.

Looming Default Reminder of Past Debt Problems

Currency expert Kathy Lien revisits a time in 1979 when the U.S. missed a Treasury bill payment, pointing out that the value of the dollar only dropped 0.6% immediately following the lapse; however, the value plummeted less than one month after the one-time default. Lien notes that it would be a mistake to attribute the drop in value on the actual missed payment, but the real reasons were increased inflation and global concerns over the security of the U.S. dollar. For more on this continue reading the following article from Kathy Lien.

Although the U.S. government has never officially defaulted on its debt, it missed payments on some Treasury Bills in 1979. Then as now, Congress was playing a game of chicken with Republicans and Democrats bumping heads on raising the debt ceiling. The debt limit was a fraction of its current levels and at the time, the dollar only fell briefly. The 0.6 percent drop in the Dollar Index was so small that it was barely left an imprint. However less than a month later, double digit inflation and concerns about the outlook for the U.S. economy along with the security of the U.S. dollar drove the greenback sharply lower. It may be tempting to attribute this decline to the short term default on U.S. debt but the Treasury started making its T-bill payments again after a very short delay.

Here’s a chart of how the dollar behaved when the U.S. government missed its debt payment in 1979:

This blog post was republished with permission from Kathy Lien.

A Glance at the U.S. Credit Rating Outlook Downgrade

Yesterday's S&P downgrade of the rating outlook for U.S. debt was outlined this morning in The Wall Street Journal. Read about what the analysts had to say in this full post from The Mess That Greenspan Made.

The Wall Street Journal provides a thorough examination of yesterday’s S&P downgrade of the rating outlook for U.S. debt in this story in today’s paper that includes the graphic below showing where we stand on our credit rating, outlook, and debt. As many analysts have noted over the last 24 hours, the warning would carry a lot more weight if the ratings firm hadn’t done such a poor job in assessing mortgage securities just a few years ago.


Officials in Japan voiced confidence in U.S. Treasuries, though the Chinese government has yet to offer an official reaction to the news, however, the head of their largest credit rating agency said the move was well deserved (according to this WSJ item, he said, “the U.S.’s actual debt repayment ability has already collapsed”). Yikes!

Meanwhile, American economists poo-pooed the whole idea of the U.S. losing its AAA credit rating, offering markets the assurance that it’s virtually impossible for America to default on its debt because said debt is denominated in dollars and we can print as many of those as we desire, a view that, sometime in the not-too-distant future may prove to be another example of how conventional wisdom is often wrong.

This post was republished with permission from The Mess That Greenspan Made.

Two Opposing Views Of The Future Of The US Credit Rating

Concern of Standard and Poor's reducing Britain's credit rating leads to the question on everyone's mind — will the US be next? On one side is co-chief investment officer of Pimco, Bill Gross who says it will likely happen, and on the other side is Treasury Secretary Tim Geithner who says no. Continue reading to learn their arguments in this post by Tim Iacono from The Mess That Greenspan Made.

Pimco co-chief investment officer Bill Gross and Treasury Secretary Timothy Geithner are at odds regarding the prospect of the U.S. losing its triple-A credit rating.

Not that it really matters.

In a world crowded with nations whose budget deficits are rising sharply and whose central banks are furiously printing money in an attempt to soften the economic pain, it seems that the general shift downward will just redefine what it means to be a good credit risk.

Kind of like, "less bad" is the new "good".

According to this report at Bloomberg, after Standard & Poor's raised the possibility of the British government getting taken down a notch or two, Gross figures it's only a matter of time until we lose our AAA credit rating in the USofA, but it won't happen anytime soon - this sort of thing should be expected when government debt is growing at near-exponential rates and the printing presses are running 24 hours a day.

Gross commented on the prospects for future budget deficits on both sides of the Atlantic:

“Both the U.K. and the U.S. have prospective deficits of 10 percent annually as far as the eye can see,” Gross said. “At some point over the next several years” the debt of each “may approach 100 percent of GDP, which is a level at which country downgrades tend to occur,” he said.
...
The U.S. will issue a record $3.25 trillion of debt in the fiscal year ending Sept. 30, according to Goldman Sachs Group Inc., one of the 16 primary dealers that trade directly with the Fed and are required to participate in Treasury auctions.

“The market knows and believes that both the U.S. and the U.K. are quite similar in terms of their debt levels and debt trends,” Gross said.

He went on to note that the Fed's balance sheet will probably increase to $5 or $6 trillion by the time they're done printing money, all the newly created dollars aimed at restoring the proper functioning of a financial system that more and more people are realizing is patently unsustainable in its current form.

Meanwhile, Tim Geithner over at the Treasury Department thinks that tumbling prices for U.S. debt are a sign of a resurgent U.S. economy, rather than an inexorable march toward the status of deadbeat borrower.

Admittedly, the term "deadbeat borrower" isn't quite correct here because any government that operates a printing press can always find a way to pay its bills - just look at Zimbabwe.

It simply becomes a question of the value of the money that is used to pay those bills.

Cutting the budget deficit will be a top priority for the U.S. government, as soon as things return to "normal" according to this report also appearing at Bloomberg:

“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television yesterday. He added that the target is reducing the gap to about 3 percent of gross domestic product, from a projected 12.9 percent this year.
...
It’s “critically important” to bring down the American deficit, Geithner said.

In its latest budget request, the administration said it expects the deficit to drop to 8.5 percent of GDP next year, then to 6 percent in 2011. Ultimately, it forecasts deficits that fluctuate between 2.7 percent and 3.4 percent between 2012 and 2019.

Absent another asset bubble of some kind - preferably the kind that both Wall Street and the government can get behind, rather than, say, surging commodity prices that hurt as much as they help - it's hard to imagine how the U.S. is going to generate enough economic growth and tax revenue to bring these deficits down anywhere close to what the White House projects in the years ahead.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.