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S&P Downgrade Report Analysis

August 9, 2011

After the dust has finally settled from Standard and Poor’s downgrade of US debt that sent markets spiraling and politicians scrambling, a picture of what the ramifications of the unprecedented downgrade emerged: pain, uncertainty and lots of blame.

The downgrade is unprecedented in US history, and no one is quite sure how markets or consumers will react, today the market finally rebounded to some degree from its free fall, but there is no way of knowing how it will deal with the downgrade in the longer term.

The clearest aspect of the downgrade fallout is both political parties to deflect blame for the downgrade. Everyone has been referencing the S&P downgrade report to justify their claims that they are blameless, and the blame rests squarely on the other side.

It is always dangerous to simply accept what politician cite from reports and studies that they know the public has not read, regardless of their political affiliation, so an analysis of the brief S&P report is in order.

The entire report can be found here, and there is even a concise overview section, so take the time to glance at it.

S&P Report

Now the report itself, and the passage you have most likely seen taken out of context:

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 act.

So the blame can be heaped entirely on the Republicans? S&P even said so, it was in the report, right? If only everyone could be trusted not to cite out of context. This passage is referring to the S&P’s (rather odd) decision to use a baseline scenario where they assume the Bush tax cuts remain in place for everyone, and the rates do not revert to the previous higher rates for wealthier Americans even though their expiration is the default at this point. This is not to say that Republican stubborn insistence on no revenue raising measures, even in the form of closing tax loopholes, is blameless in the downgrade. It is to say that this passage which will be used in the partisan sniping has more to it than the out of context passage would imply.

The S&P, for all of its problems with reliability, and arithmetic (they made a 2 trillion-dollar error in projecting US debt to GDP ratio), is fairly even-handed with the blame for the downgrade, as it should be really.

Judging from the report, S&P was thoroughly unimpressed by the debt ceiling deal:

The fiscal consolidation plan… falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.

They also recognize that all of the potential savings could be a mirage, as I mentioned in my earlier post here, and warn of further consequences if this were to be the case:

We could lower the long term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to

S&P elaborates on its rationale for downgrading the US, and there is more than enough blame to go around:

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.

And there it is. Both political parties are to blame. Neither party was willing or able to compromise regarding the lines they had drawn in the sand. For Democrats to place entitlements on an untouchable altar, when entitlement spending is the main driver of the looming debt crisis is short-sighted, and assuming that somewhere down the line, when the crisis gets big enough, a future congress will find a way to fix it is naive. And Republicans, denouncing any revenue increases, even if they were in the form of closing tax loopholes that have distortionary effects on the market, at a time when revenue is at a low point due to the weak economy, deserve to be called intransigent in some respects.

So ok, maybe there is some degree of blame on both sides, but surely the report implies some leaning on S&P’s part as to which consolidation plan, Republican spending cuts or Democratic tax increases, is preferred; which parties platform would be more likely to get this country back on the right track:

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.

S&P, its myriad of problems as a rating agency aside, is like the American people. Both are less interested in dispensing blame than seeing real progress made on addressing the bleak state of US finances, if only our political leaders felt the same.

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