Why Did The U.S. Lose It's AAA Credit Rating?

The two perspectives being stated by the White House are, (1) S&P (the group who downgraded the credit rating) is bad at math and we shouldn’t be downgraded, and at the same time (2) the contention over raising debt limits and raising revenues is directly to blame and we should blame the Tea Party for those contentions. At the same time investors tell us that we have been waiting for a downgrade for some time now.  Were investors blindly speculating? What convinced them this was coming and what convinced the White House that they struck a deal well enough to avoid the downgrade?

One assumption seems to be that we don’t suddenly care about S&P credit ratings, which doesn’t seem to be true.  In terms of selling our national debt in the form of Treasury Bonds to an international and national audience, we’ve worked with and benefited from those rating for a very long time.  The fact that we protest too much proves we care. Saying we don’t care or that S&P is wrong is just an effort to leverage U.S. dealing power against the valuation of the credit rating agency.  Consider that in the last year Italy’s debt was downgraded to nearly nothing and their governments response was to raid that agencies office and drag them into court on what might be false claims staged to avoid having to face their debt and credit rating problems.  The U.S. hasn’t taken it that far, but then again this just happened.

The next assumption is that the conflict is in fact the problem, and this draws a direct line to the Tea Party putting up a stink.  The logic that follows implies that a politically united raising of the debt ceiling would not have resulted in a downgrade. It seems to imply that the haggling was the real problem. Is this assumption true?  To answer this question you have to have read the S&P downgrade document to get a better understanding of why the credit rating was lowered.

“We lowered our long-term rating on the U.S. because we believe that the
prolonged controversy over raising the statutory debt ceiling…”

Reading the first part of the first sentence in the Rationale section of the credit rating document implies that the White House is correct. And if you only read that part you might agree with them, but you wouldn’t be getting the whole picture.  It is true that the prolonged controversy implied a problem, but what was the problem really?

To answer this question (and assumption) we need to answer the last question above: Were investors blindly speculating? What convinced them this was coming and what convinced the White House that they struck a deal well enough to avoid the downgrade?

Back on July 14th, 2011, S&P put the U.S. on the CreditWatch list. This is when investor insights changed from speculation to affirmation: what they assumed could happen (lowering the credit rating) was about to happen if big things didn’t change (fiscal policy didn’t unite in a manner that made a sizeable difference). So this is what people meant by knowing this was about to happen. Which leads us back to our previous question:  If we did not fight and simply raised the debt limit (i.e. printed a huge roll of new cash into Uncle Sam’s pocket to pay for the debt interest we owe) could we have avoided the downgrade?

Further reading beyond the first sentence in the downgrade document reveals the truth about the rationale behind the lowering of our national rating.

“Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty, consistent with our criteria”

There are two concerns with what is being said here. First, our rising debt burden is a problem. China a few days ago made a public national statement about the U.S. borrowing it’s way out of our financial problems. Our own credit agency is saying our debt (borrowing) is a problem and is in fact THE problem. Secondly, and this is also as much a part of the rating downgrade as the problem itself, the fact that we cannot agree how to resolve the problem is part of the problem.

Imagine being a partner in a small business. You and your partner have been trying to stir up business for some time now but you two cannot agree on what methods are the most effective. You might think that swag (giving things away) stirs up business while your business partner thinks that coupons (discounts on doing business with you) is the way to go.  In the mean time you have run up some huge debts to keep the business venture going. Now, the debt collectors are calling and you have to deal with your situation. At the same time your credit rating has gone into a specifically negative watch state because you two cannot seem to stop fighting about how to solve your debt problems. You tell you partner that you should put a stop on future planned orders of swag, which is creating debt, and at the same time your partner thinks that you should burn all of your coupons and raise your prices to afford the swag. You go ahead and cut a deal to pay for the next three months of debt with a public promise to resolve how to cut back on the amount of debt you are having to incur to stay alive as a business.  As a result the credit agency takes you off of the negative watch list, but because you still cannot agree on how to reduce your debt (or even slow down the rate of debt increase in reality) they lower your credit rating because your debt problems are not really about to get resolved.

In this analogy, you can see that the credit agency doesn’t care how you spend your money (swag or discounts) or how you pay your debt (lowering future planned spending significantly or raising taxes), but they do care that your debt to income ratio remains strong both now and in the future.

So is the White House correct that if we didn’t haggle and simply borrowed more money to resolve the current debt interest payments that we could have dodged the credit rating reduction? That doesn’t seem to be true. Under the Presidents approach he would want to keep spending money on swag while raising income (revenue) to pay for it, but at the rate we are compounding debt interest we are in line with spending as much on national debt interest as military defense per year by 2020, which means that we are not resolving our debt to income ratio problem. Would cutting future planned spending resolve the issue? At this point we are looking at one of the largest expansions of government in modern history (meaning more government spending than what I’ve seen in my lifetime). I don’t believe we can cut enough to make the difference.  The bar on spending is too high right now.  Too many people will complain with big enough cuts (whether you are poor and living off of government subsidies or wealthy and getting various tax credits based on assets and living conditions).

The answer in the short terms is: spending cuts that pain everyone a little and raised taxes which pain everyone a little. In the economy of my personal life this would be like deciding to spend less on stuff I want but could live without while saving more money than I really want to all at the same time.

Some people are likening this current president with Jimmy Carter.  They are not far off.  Others want to imagine that he is closer to Bill Clinton. All I have to say is that while the debt problems and conflict in congress is a reminder of Carter’s Iran Contra affair (in some very simple analogous ways) Clinton did raise taxes but also significantly reduces the debt to income ratio (in government a low debt to income ratio is what people call “small government”) over his eight years in office. I am not a fan of Clinton or Carter really, but in terms of economics I would take Clinton over Obama any day. The fact remain true, spending is the real problem. If spending and debt weren’t an issue, we would not be in the situation we are in.

So am I advocating for raising taxes? Imagine the business partnership again.  If your business partner spent money like water and you don't want the company to collapse, then you may have to bail the business partner out by taking on a weekend job at the Dairy Queen to raise your income level. Who would be happy with having to do that? I wouldn't do it unless I had a promise in writing from my business partner that said they are going to kill all of this mad spending.  And fundamentally, I believe this is what the "Tea Party" is after.  We may have to raise revenues and we will have to cut spending.  This argument was unavoidable when you look back at it, as far as I can imagine.