Deconstructing The Absurdity

S&P strips U.S credit ratings; Government cries foul!

In Barack Obama, Debt Ceiling, Democratic Party, Republican Party, Tea Party, U.S Congress on August 6, 2011 at 6:29 am

So it finally happened. All this while Washington was in a fight with itself to save the economy and protect the full faith and credibility of the nation. Some congressmen/women however were eager to let the country go ahead and default or just prioritize and pay the interest only. On Friday after the markets closed, S&P decided to downgrade the U.S credit rating from AAA to AA+. That A+ does look nice on a college transcript but here the downgrade has been done with a negative outlook. The government officials on both sides of the aisle are furious at a nearly $2 trillion error on the part of the rating agency.

Among the many reasons cited by S&P which led to the downgrade two of them stand out. S&P stated that the fiscal plan released by the U.S Congress falls short of reducing the deficit. Rep.Barney Frank (D-Mass), the former chairman of the House Financial Services Committee said, “The private debt has been over valued and the public debt has been under valued by S&P.” Government official are screaming foul and have pointed out basic math problem with S&P’s calculation. The  Treasury attacked S&P’s calculations, saying: “A judgment flawed by a $2 trillion error speaks for itself.” Many lawmakers are also of the opinion that these credit rating agencies have been given too much power. Also, S&P alone downgrading the U.S credit rating will not have much effect on the country’s economy. All three agencies, Moodys, S&P and Fitch downgrading the U.S at the same time would have cause significant financial trouble. Pensions would be greatly affected. Interest rates will shoot up for student loans and mortgages etc. Washington calling this an “amature hour at S&P’.

In midst of all this there was indeed a big black spot that S&P pointed out. It is something nobody can deny.

S&P blamed political weakness and instability for triggering the downgrade apart from criticizing the budget which would not do much to lower the deficit.

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.

S&P further stated that it would downgrade the credit rating to AA, “if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume”.

There is no brainy geeky puzzle to solve here. The message is plain and simple. Washington can cry wolf but the markets and the world are just going to call its bluff. The fact of the matter remains. The government is heavily divided and credit rating agencies are beginning to feel that the political environment in the United States is unreliable. House Republicans hinting at solving every issue and specially debt issues the way it just played out; Cutting more than a dollar in spending for a dollar raised in the debt ceiling is how the GOP wants to proceed on future fiscal negotiations. The world and credit rating agencies have a different opinion about it. S&P critizied both parties and had harsh words for the Republicans stating, “We have changed our assumption … because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”

That however did not stir the Republican contenders for president. They were very quick to pick up this issue as a humiliation under Obama’s term. When Republicans say things such as “No Revenues”, “Nothing can pass the house”. “We will always have deals like this”, THIS is what happens. As much as politicians would love to deny it. This downgrade was more of a result of severe lack of political stability rather than fiscal concerns. U.S Treasury is the most transparent and has the best known financial instruments in the world. This downgrade will have no impact on the paying or borrowing capacity of the treasury. This will have major impact on the political system and the way policies are being formed in this country. This event should force the Republicans to rethink their position on taxes and help eliminate the Bush tax cuts which would account for an additional $3 trillion over the next decade. “Investors have voted and are saying the US is going to pay them. US Treasury’s are still the gold standard,” Mark Zandi, chief economist of Moody’s, told the Associated Press. SIFMA, an US financial industry trade group, estimates that the downgrade could add up to 0.7 of a percentage point to the yield (interest rate) of US government bonds, increasing the cost of servicing public debt by $100 billion. As a rule, a lower credit rating means higher borrowing costs for debtor nations. But the size of U.S and it’s capital markets are a key factor in the global economics. After a week of plunging financial markets with Wall Street down as much as 515 points (-4.3%) it is yet to be seen how the market reacts to the downgrade when it reopens on Monday.

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