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.

Focus on Reducing Deficit Risky, Analysts Say

President Barack Obama made recent comments that have some economists questioning the administration’s plan to maintain fiscal responsibility without endangering an already fragile economy. President Obama reiterated the need for deficit reduction, which could mean an increase in taxes, cuts in federal spending or both, and many believe either of these moves could jeopardize economic growth. Political pundits argue Republicans may support a U.S. default if it means a boost in polls during election time, which is a cause for concern if it increases the chances the administration may be forced into a position that makes avoiding default impossible. For more on this continue reading the following article from Economist’s View.

This is in the mid-range of the Brad DeLong Shrill-O-Meter, but I think it's safe to conclude that he's not happy with the president's remarks in yesterday's press conference:

This Is Very Bad: Barack Obama Fail Department, by Brad DeLong: Can't anybody in the White House play this game?

Barack Obama:

Transcripts: There are a lot of folks out there who are still struggling with the effects of the recession. Many people are still looking for work or looking for a job that pays more. ...

But there are ... steps that we can take right now that would help...

Of course, one of the most important and urgent things we can do for the economy is something that both parties are working on right now, and that's reducing our nation's deficit...

No. No. No. No. No. No. NO. NO!!!!!!!!!

Absolutely the last thing, the last thing, the country needs is to cut federal spending or raise taxes in fiscal 2011, 2012, and it is now looking like fiscal 2013 as well.

Absolutely the last thing the country needs.

It gets worse. Obama:

[B]ecause of the work that's been done, I think we can actually bridge our differences. ... Nobody wants to put the creditworthiness of the United States in jeopardy. Nobody wants to see the United States default. ...

Does Obama read? There are some people who are looking forward to a default. And some of them are in the Republican legislative caucus--or so John Bresnehan and Jake Sherman claim:

"Who has egg on their face if there is a sovereign debt crisis, House Republicans or the president?" said another senior GOP lawmaker.

We have Republicans threatening to default on the debt and blow up the economy if they aren't allowed to put the economy at risk in another way -- through immediate deficit reduction -- and a president selling the demands from the other side as a jobs package. To make it worse, some Republicans seem eager for default to happen based upon the false belief that they'll somehow gain political advantage for wrecking the economy. No wonder the economic outlook is so grim.

With the economy struggling to get back on its feet, "Absolutely the last thing, the last thing" we should be doing right now is making threats or enacting policies that increase the risks of an economic setback. I think it's important to realize that the threat to default on the debt puts the economy at risk even if it is never acted upon, especially as the critical date to lift the debt ceiling draws closer. Republicans aren't just threatening to put the economy at risk in the future if they don't get their way, they are already doing so. If this continues there will likely come a point when markets get the jitters, and if that happens, watch out.

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

Is Deficit Myopia Leading To A Longer Recession

The outcry about the deficit is making it difficult for government to use fiscal tools to help pull the economy and jobs out of its weakened state. The right fiscal stimulus will reduce the deficit if spending efficiently creates jobs. See the following post from Economist's View.

Joseph Stiglitz:

Obama must resist 'deficit fetish', by Joseph E. Stiglitz: ...Don’t give into deficit fetishism. ... The real risk for America right now is a prolonged weak economy - something that a mindless focus on deficits can help ensure.

The deficit hawks from the banking system went on vacation from the fall of 2008 through the spring of 2009, while they demanded money be doled out freely - to themselves. But now that the public clearly won’t stand for another free lunch at its expense, the deficit hawks are back at work, more vocal than ever about the need to cut government spending.

They say it was necessary to the health of the economy to dole out money to the banks; but not necessary to the health of our society to make sure everyone has access to health care. It was not acceptable to alter the contracts of the AIG personnel, even those “key” and irreplaceable personnel who made the mistakes that led to a $180 billion bailout, but acceptable to break the social contract between America’s elderly and the rest of society, by cutting back on Social Security.

The bankers were short sighted when getting the country into the mess. But deficit fetishism is equally short sighted. ...

Worrying about the deficit can be good, if it focuses attention on four big issues:

(a) What kind of spending yields high returns?

(b) What kind of spending has the largest multipliers? We can increase spending that stimulates the economy a lot, decrease other spending, and still have a stronger economy.

(c) Are there tax increases that will not hurt output and employment, or at least not much? Increasing the progressivity of the tax structure and closing some corporate tax loopholes can, for example, raise revenue and lower the deficit, as employment increases.

(d) Are there other ways of stimulating the economy, e.g. by eliminating some of the problems in access to credit, or inducing banks to lend more for job creation, rather than helping create bubbles? The answer is clearly yes, but that means being a little tougher on the banks than we have been. ...

There are no easy ways out of the mess that the financial sector has created. But giving into mindless deficit fetishism risks higher unemployment...

Deficit fetishism is alive and well, but I'm not sure it is being driven mainly by the financial sector. People like Pete Peterson -- Chairman and CEO of Lehman Brothers from 1973 to 1984 -- are certainly behind some of it, so they aren't blameless either, but it seems broader than that.

The long-run trend line for the deficit is being driven mainly by health care costs. That needs to be kept separate from variations around the trend designed to stabilize the economy through the business cycle. Stabilization policies -- what we need more of right now but won't get due to deficit fetishness -- have little to do with the long-run trend for the budget.

There are two problems that we need to fix. One is the employment problem that exists right now, and we are not doing enough to fight that problem. The last line in the Stiglitz piece above is "The economy needs another stimulus, and it needs it now." I fully agree.

The second problem is the long-run imbalance in the budget, and that can only be solved by health care reform that brings the growth in costs down to a sustainable level. Whether we spend more or less to fight the employment problem that exists right now has little to do with solving this problem, and there's no reason at all for concern about the long-run problem to stop us from doing more now. No reason except deficit fetishness that refuses to separate the long-run health care cost problem from the largely independent short-run needs of those who are struggling to find employment in an economy that is still losing jobs.

This post has been republished from Mark Thoma's blog, Economist's View.

Obama Changes His Tune On Deficit

After campaigning for and signing into effect more than $800 billion in federal stimulus, President Obama now is worried that too much debt could create a double-dip recession and recently spoke out against deficit spending. Although the federal stimulus package delivered limited and underwhelming job growth results, Democrats in Congress are already at work on a second package targeted at spurring job growth – one that will likely result in more deficit spending. See the following from The Street.

President Obama, the champion of stimulus spending, is suddenly worried about an overload of government debt.

After pressing Congress to approve an $800 billion package of infrastructure projects, unemployment benefits and tax cuts during his first month in office, Obama is now warning that too much debt could cause a double-dip recession.

Even more intriguing about this shift in rhetoric is that he chose to deliver the new message to Fox News, News Corp. (NWS Quote) network with which Obama has been feuding over a perceived conservative bias.

One can only assume that the detente with Fox and the decision to talk about debt issues is a politically calculated move to assuage Republicans who have been making deficit spending a centerpiece of their resistance to Obama's many initiatives, in particular health care reform.

Obama also acknowledged that he's in a precarious position in terms of boosting job creation to keep the recovery going while reinstating some fiscal discipline.

In the same interview with Fox, Obama talked about the need for new measures to spur companies to create jobs. Obama's Democratic Party chiefs in Congress are in fact working on new legislation they hope will bring down the unemployment rate from the staggering 10.2% level. Any government-sponsored initiatives along those lines will add to the deficit one way or another.

It's essentially an admission of failure that Democrats are now working on a second job-creation package.

So far, the stimulus spending isn't showing great results. At the end of October, the Obama administration released a report showing that about 650,000 jobs had been saved or created at a cost of $150 billion. That's about $230,000 per job.

I'm not knocking Obama or the Democrats for trying to stoke the economic recovery, for the trillions of dollars spent to bailout the financial industry or for realizing that they may need to do more to help the 15 million unemployed Americans find new jobs.

It's just the idea that Obama is now critical of deficit spending that I find so ironic.

This post has been republished from The Street, an investment news and analysis site.