Relevant and even prescient commentary on news, politics and the economy.

THE Reason for the Downgrade

Or, Barack Obama sucks at 11-dimensional chess.

On July 14, 2011, S&P was assuming that 2001 and 2003 tax fraud deferrals would expire at the end of 2012 [Update: link updated, via MG; PDF–see page 4].

It is no longer making that assumption, which is worth another $4T. Brad DeLong annotates/redlines the press release without comment on that part:

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 act.

English translation: even though extending the tax cuts would require an affirmative action of both houses of Congress and consent from President Obama (or veto override by vote of 2/3 of both houses), we don’t believe this will happen or we would have kept our innumerate mouths shut in the first place (or at least after Treasury called us on our McArdlesque calculations).

Our revised upside scenario–which, other things being equal, we view as consistent with the outlook on the ‘AA+’ long-term rating being revised to stable–retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, we project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and to 87% by 2021. to 77% in 2015 and to 78% by 2021. [redlining by BdL]

English translation: if we thought Barack Obama and his Administration both were serious and would be successful, we wouldn’t have left the U.S. on credit watch for possible downgrade. But we don’t, nyah, nyah, nyah.

As I noted earlier today, it’s not coincident that the twenty countries still rated AAA (with the possible exception of New Zealand) all either are tax havens, authoritarian “democracies” (Hong Kong and Singapore) or have Mandatory National Health Insurance.

If S&P on 14 July had said, “The U.S. needs to control its health care costs or we will downgrade it,” no one would have said a word of dissent. But the downgrade S&P presented is not based on the root issue; it is based on the belief that temporary blackmail does long-term damage.

It’s punditry, not analysis. Even Barack Obama deserves better.

At least until he fails 11-dimensional chess the way S&P believes he will.

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Ratings QOTD

From Crash of the Titans, pp. 33-34:

The largest chunks of these [created by Merrill in the winter of 2006-2007] CDOs still carried triple-A ratings, at least in name, because the credit rating agencies hadn’t bothered to recalibrate their antiquated ratings models. But almost no one was willing to buy the triple-A portion of these bonds from Merrill because the rest of the marketplace knew what the credit rating agencies and [Osman] Semerci [then Head of Merrill’s FICC area] didn’t know: that the entire world of mortgages had turned into radioactive waste. [UPDATE: emphasis mine]

Two quick reactions:

  1. Sh*t, I knew that by late January of 2007, and I wasn’t being paid to know it.
  2. Note that this paragraph actually highlights an implicit disagreement that Robert and I have been arguing through on this blog for the past few years: whether ratings are a signal or the primary signal that investors use. Or, as Andrew Samwick—yes, this is my day for agreeing with conservatives (though not libertarians) on root-cause analysis—points out:

    I don’t think potential investors in U.S. Treasuries relied too much on its previous AAA rating in actively valuing the bonds and bills. And even if they did, they should be only minimally bothered by its current AA+ rating. Potential investors have plenty of public information on current and projected cash flows of the U.S. government. In those circumstances, there is little value added by a ratings agency’s grade.

When the market disagrees with the ratings, the ratings lose. So what has been happening today in the post-S&P bond market?

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Forthcoming Tyler Cowen articles that will be Echoed by Felix Salmon

References are here (Cowen) and here (Salmon).*

  1. Just because Charlie Sheen got drunk, did some other drugs, and committed adultery doesn’t mean he’ll do it again.
  2. Just because someone who calls himself Jack the Ripper has killed two women in London doesn’t mean he’ll do it again.
  3. Just because the U.S. dropped a hydrogen bomb that emits massive amounts of radiation on Hiroshima doesn’t mean they’ll do it again.
  4. Just because Megan McArdle makes mistakes when she tries to do financial analysis doesn’t mean she’ll do it again.

Feel free to add more in comments.

Cowen, by the way, wins the intellectually-inconsistent-in-a-short-period award (partially because Felix’s argument meanders more than Moses in the desert):

[T]he “we should have had a much bigger stimulus” argument is unlikely to go down in intellectual history as the correct view. Instead, Ken Rogoff and Scott Sumner are likely to go down as the prophets of our times. We needed a big dose of inflation, promptly, right after the downturn. Repeat and rinse as necessary.

Shorter Tyler Cowen: we didn’t need to put a lot more dollars into the economy than we did. Instead, we needed to put a lot more dollars into the economy than we did.

UPDATE: Mark Thoma is collecting reaction to the S&P’s alleged rationale as only he does. See especially Economics of Contempt’s post and this e-mail from the someone who has Been There and Done That.

*Who follows up his far-too-nuanced-for-me “FAQ.” But I am a Bear of Very Little Brain compared to such analysis.

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Game for the Weekend

Find a set of Mortgage-Backed Securities that are (1) still rated AAA by S&P, (2) have a WAL the same as (close to) an on-the-rin US Treasury, and (3) still have a Factor within 5% of the expectation of a generic MBS of that maturity  (that is, are not clearly impaired).

Post the CUSIP(s) in comments, along with that of the reference UST, and let’s track relative values on a regular basis for the next several months.

Anyone betting on where the relative value will be?

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Moody doesn’t like the US

From the latest Financial Times:
Moody’s says spending threatens US rating

The US is at risk of losing its top-notch triple-A credit rating within a decade unless it takes radical action to curb soaring healthcare and social security spending, Moody’s, the credit rating agency, said on Thursday.

In its annual report on the US, Moody’s signalled increased concern that rapid rises in Medicare and Medicaid – the government-funded healthcare programmes for the old and the poor – would “cause major fiscal pressures” in years to come.

Steven Hess, Moody’s lead analyst for the US, told the Financial Times that in order to protect the country’s top rating, future administrations would have to rein in healthcare and social security costs.
“If no policy changes are made, in 10 years from now we would have to look very seriously at whether the US is still a triple-A credit,” he said.

Cut them taxes baby! Yeah!

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