Key things to know about S&P’s rating downgrade of U.S. debt

Last night’s rating downgrade of the U.S. debt by Standard & Poor’s will probably have minimal economic impact. In an increasingly uncertain global economy, U.S. debt still looks like a pretty good buy so we’ll see little if any change in key interest rates. That’s my guess at the moment.

But the downgrade is still a big deal.

There seem to be three general reasons for the downgrade:

  • the ongoing and future structural deficits in the U.S. (the federal government has been laying out far more money than it has been bringing in over the last 40 years, esp. over the last decade; future costs of Medicare and Medicaid pose particular problems)
  • the increasing uncertainty about the ability of U.S. leaders to solve the long-term problem
  • the very real possibilities of political brinkmanship over the debt ceiling that could lead the U.S. to default on some of the bills it has already incurred
Should we trust S&P to make this decision? Yes and no.
Standard Poor’s didn’t just miss the bubble. They helped cause it. They were paid by the banks to award their AAA-stamp of approval to all manner of financial products that were anything but riskless — which, ironically, makes them an accessory to the resulting explosion of U.S. debt.  [. . .] But that doesn’t make Standard Poor’s wrong in this particular case. [. . .] After Republicans in Congress spent three months weighing whether or not to default on our debt and Senate Minority Leader Mitch McConnell said that paying our bills would never again be a foregone conclusion, can anyone really argue with that? After every Republican presidential candidate save Jon Huntsman either remained silent on, or flatly opposed, the deal to raise the debt ceiling, can anyone really say that U.S. debt is completely riskless? That there’s no chance of a political miscalculation, and if there is such a chance, that they can perfectly predict the outcome of the ensuing chaos?
A few key snippets from S&P’s statement:
  • The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
  • We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process.
  • Republicans andDemocrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.
  • Standard & Poor’s takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.’s finances on a sustainable footing.
  • Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012,remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the [the recent debt ceiling extension].
  • The outlook on the long-term rating is negative.
It’s interesting that they are now assuming a continuation of the Bush tax cuts. As I’ve noted before, unless Republicans in Congress show some serious willingness to compromise on revenues, those tax cuts will end about two months after the 2012 election.