Sunday, August 7, 2011

S&P's Rating Folly, Part 2: Grading Political Will

 In April, we thoroughly covered how a threatened S&P downgrade of US debt would be economically meaningless to a sovereign nation with debt issued in its own currency.  The April S&P warning fueled the political divisiveness of public debate placing the S&P directly in the political game as a player influencing political debate.  Credit ratings agencies are federally licensed and regulated businesses as NRSRO's (Nationally Recognized Statistical Rating Organizations) and they are not lobbyists, although they escaped financial reform after the Global Financial Crisis which they helped precipitate with misleading credit ratings for companies that failed and investments which were actually toxic.

On Friday, S&P downgraded United States debt from AAA to AA+ despite a $2 trillion S&P error in their analysis.  Economically, this is meaningless.  You only have to look at the low yields on Japanese bonds after losing their triple A credit rating almost ten years ago.  Is the S&P engaged in a political agenda contrary to its regulated purpose?

It appears from the S&P report that the primary concern was the lack of political will by elected representatives and officials to come to a reasonable agreement prior to a repetitive political drama over extension of the debt ceiling.  The job of the S&P, as a NRSRO, is to provide an independent statistical analysis of financial credit worthiness which can be relied upon by investors and they have not demonstrated any compelling analysis in the report.

Felix Salmon has noted that default is an act of political will not an econometric decision and that "’s fair to pin the lion’s share of the blame on the existence of the debt ceiling."  The political debate over the debt ceiling was vicious and destructive and exactly why Section 4 of the 14th Amendment to the U.S. Constitution was passed after the Civil War.  The debt ceiling law is not only destructively counter productive, it is legally superfluous.  Conservative economic commentator, Megan McArdle, went so far in noting the lack of political will in the debt debate and the obvious necessity to increase the debt ceiling that she said, "...I'm afraid I think that the lion's share of the blame goes to the GOP, which escalated to this completely unnecessary showdown, and then gave up any hope of a grand bargain because it would have required some revenue increases."  Given that President Obama believes, and has voted in the past to not raise the debt ceiling as a Senator, in deficit reduction and aided and abetted the deficit hawk elements, although he recognized the need for revenue increases, he appears to be getting off light in the lack of political will department, which is unfortunate since he has demonstrated little political will since assuming office.

Did the S&P downgrade United States debt on the lack of political will in the political process in the United States?  On page four of the report which is linked above, the S&P states "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."  They are saying the Republicans in Congress lack the political will to to do what is reasonably necessary to govern in a fiscally responsible manner consistent with the economic needs extant.  The mainstream media has ignored this sentence in the report, because it exposes the political charade of the debt ceiling debate as economically incompetent wasted demagogic rhetoric on the debt rather than one of governance.

The S&P, however, used these same tactics, in combination with Moody's, in the 1990's in Canada to assist financial interests in slashing unemployment insurance and health care just as they used their power in 2000 to squash mortgage lending reform.  As the economist Rajiv Sethi argues, perhaps, it is time that the credit ratings agencies, which were so instrumental in profiting from credit ratings which were so unreliable they directly contributed to the Global Financial Crisis, be stripped of their legally protected status and monopoly power and made to compete on merit of work with full legal fiduciary liability to the investing public in a democratic society.  It is coming to a decision point about whether we are a corporatist market state or a republican democracy.

Jesse's Cafe Americain observed that Friday's market showed visible signs of movement of knowledge of a hidden agenda with respect to the expected S&P announcement, as Felix Salmon and Megan McArdle also mentioned, and concludes that the class war will only intensify now as governance is being cast aside.

Futures at this point in time are mixed with the DOW positive and the Nasdaq and S&P 500 negative.  The German Dax futures are negative.  The Middle East stock markets on Sunday were down with the Israeli stock market down 6.99% (TA-25), supposedly as a reaction to the US downgrade.  Any down movement on Monday solely attributed to this downgrade would be foolish herd behavior and soon recognized as such.  However, the eurozone meeting of Central bankers is this Sunday night and the professional market will be watching what the ECB does on Monday.  Here are the economic reports, including retail, household debt, and FOMC meeting (which is expected to result in the FED saying they are watching and waiting), which will come out this week and could potentially impact the market.

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