S&P Downgrade Brought on by Republican Obstructionism

Jeff Madrick

There are lessons to be learned from S&P’s report, but none of them are financial.

Does anyone really think that Standard & Poor’s downgrade of U.S. debt would have occurred unless there had been the Congressional stand-off on raising the debt ceiling? For all of S&P’s handwringing about the nation’s debt problems, Congressional recalcitrance was the driving issue. So when the press says neither the Democrats nor the Republicans can escape blame, it is in truth nonsense. The showdown caused the downgrade, not the nation’s financial liabilities, and Republicans deliberately caused it in pursuit of their own political and ideological goals.

Of all the silly comments about the Standard & Poor’s downgrade of U.S. debt, those of Senator Lindsey Graham might take the cake. He said any CEO would have to quit if his or her company’s debt was downgraded. But Graham does not realize that private corporations are essentially dictatorships, only occasionally beholden to shareholders. President Obama has to deal with the deliberately obstructionist Congress led by Graham’s party. Republicans could have lifted the debt ceiling and still fought for their case. Instead, they played chicken with U.S. credit in the name of ideology — or, more likely, to target the President.

S&P adds to the confusion by making believe there are serious budget issues here as well. It admits the political showdown was a cause for concern. Then it goes on to talk about America’s need to get its finances together. Let’s be very clear: There would be no downgrade now if it were solely based on budget issues. It is all about politics.

And about S&P’s clairvoyance on budget matters, the record is mostly a bad joke. Few will remember that the credit ratings agencies gave Penn Central a high rating in 1970 just before it went bankrupt. Similarly, it gave New York City high ratings just before the city’s brush with bankruptcy in the mid-1970s, about which we are reminded by Governor Carey’s death. (He was the man who managed the city’s rescue along with a then rather young Felix Rohatyn, the investment banker.) The credit ratings agencies gave Enron a high rating before it became the biggest bankruptcy of all time. And of course it doled out triple-A ratings to tranches ofcollateralized debt obligations, and even synthetic CDOs, which were blatantly undeserved. A mistake? The ratings agencies made a lot of money with those kinds of mistakes, as the Financial Crisis Inquiry Commission made clear in its recent report. These CDOs were composed of subprime mortgage bonds. Defaults of 8 or 9 percent, not just the 25 percent or so we wound up with, caused those triple-A tranches to plummet in value. How could they not know that? Conflicts of interest were rife, of course.

Now Fannie Mae and Freddie Mac are being downgraded because of S&P’s decision. Some municipalities will be as well. So there is one other lesson to be learned here. If S&P really has that much influence, financial markets are hardly efficient at all. There is no new financial news here, no new turns in the budget fight, and no new political news. Markets should have built these concerns into prices already. An S&P announcement changes almost no real world conditions, only perceptions.

My guess is the fallout from S&P’s move will not be bad. Some fairly amateurish calculations — note its enormous arithmetic mistake of $2 trillion — by S&P shouldn’t be affecting markets. What is affecting markets is that the underlying American economy is weak, and that in turn affects the rest of the world. This morning as I write, interest rates are not rising sharply as you’d expect from a downgrade –in fact, some Treasury rates are plunging — but stocks are falling sharply as you’d expect from a weak economy. We should also keep in mind that a weak U.S. economy is also affecting the outlook for Europe. Any news of economic weakness in the U.S. can affect these markets, because it will mean less demand for goods and a lower dollar. It is not only European financial uncertainty that is affecting U.S. markets.

But the U.S. debt downgrade is driven by politics, not economics. And here the Republicans bear all the blame.

This article was originally published in New Deal 2.0.

4 Responses to “S&P Downgrade Brought on by Republican Obstructionism”

  1. Pardon my French, but I must agree with Robert Kuttner, who called S&P Triple-A idiots.

  2. Nagesh says:

    What matters most is that both Republicans and Democrats managed to come to an agreement on the debt deal. Political showdowns are part of the democracies. Does S&P opine that political showdowns must not take place. When economy is weak, political show downs are natural.

  3. That’s silly, the agreement is not the important thing. The substance of the agreement is what matters, and in this Obama caved. Since there is no debt problem, and the economy is weak because of lack of fiscal stimulus, what the economy actually needed is that Obama did not compromise and even took a constitutional stance to act unilaterally. Two things are important in this whole thing. First, both sides do NOT have reasonable arguments, only one does. Second, we DO know how to get out of a recession. This was the showdown of a very dysfunctional democracy. And NO Republican menaced to not increase the debt ceiling during Roosevelt’s administration.

  4. Joseph Pearl says:

    Thanks for posing the question of whether the U.S. debt downgrade would have happened if there wasn’t stand-off in congress. interesting article.

    Joseph S. Pearl, LL.M. – A Professional Law Corporation
    1400 Chester Ave., Suite C
    Bakersfield, CA 93301