Posts Tagged ‘budget control act of 2011’

Ratingzzz

6 August 2011

For years I taught money and banking under the impression that U.S. Treasury bonds carried no rating at all. I thought they didn’t need to be rated and that the rating agencies agreed. I thought the fact that bondholders accepted lower interest rates on Treasuries than on any other bonds, even AAA-rated bonds of other entities, meant they regarded T-bonds as the least risky (and most liquid) bonds out there. A related issue is whether there’s any point in rating the debt of national governments whose finances are an open book, unlike those of corporations who open their books for the rating agencies but don’t have to for the public.

Standard & Poor’s downgrading last night of Treasuries from AAA to AA+ reminded me of all that. Do bondholders really need S&P, Moody’s, and Fitch to tell them whether T-bonds are safe? Anybody who follows the U.S. fiscal news  — e.g., anyone in the bond market — would have their own judgment on the matter. Call me cynical, but I find the timing of the announcement suspicious. First, it comes rather late, as it was clear five days ago that the Budget Control Act of 2011 was going to pass and what the substance of it would be. Second, it comes at the start of the weekend, two days before the markets reopen; that’s plenty of time for other news to come along and offset whatever effect S&P’s announcement has on the markets. My cynical hunch is that S&P is afraid the announcement will have no effect on the T-bond market, thereby underscoring their own credibility rating, which has been F ever since it came to light in 2008 that they’d been rubber stamping toxic bundles of subprime mortgages as AAA. I think their announcement is their way of gambling that if the T-bond market ever does go south, they can say they called it first. (Kind of like those ridiculous predictions every week on “The McLaughlin Group.”)

As usual, Krugman nails it. He acknowledges that the intransigence of Congressional Republicans makes any kind of meaningful long-term debt deal unlikely, but says:

‘On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

‘Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.’

In passing the Budget Control Act, Washington lawmakers put deficit reduction ahead of job creation, against the wishes of the public, Keynesian economists, and even (apparently) the stock market. Yet it wasn’t enough for S&P, who say the way out of this hole is to dig even deeper. No, S&P, slashing spending and raising taxes in a depression doesn’t improve our financial health. Krugman again:

‘More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. The agency has suggested that the downgrade depended on the size of agreed deficit reduction over the next decade, with $4 trillion apparently the magic number. Yet US solvency depends hardly at all on what happens in the near or even medium term: an extra trillion in debt adds only a fraction of a percent of GDP to future interest costs, so a couple of trillion more or less barely signifies in the long term. What matters is the longer-term prospect, which in turn mainly depends on health care costs.

‘So what was S&P even talking about? Presumably they had some theory that restraint now is an indicator of the future — but there’s no good reason to believe that theory, and for sure S&P has no authority to make that kind of vague political judgment.

‘In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.’

Ironically, the U.S. attained its AAA rating in 1941, just as we were heading into World War II and the (publicly held) national debt was about to explode, to about 140% of GDP, roughly double what it is now. S&P evidently took the long view then.

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‘The market is rational and the government is dumb’

3 August 2011

The above quote is a favorite of former House Speaker Dick Armey (R-TX). He even used to write it on the blackboard on the first day of class when he was an economics professor. Armey has been out of government for years, but as a founding member of a Tea Party group, he’s been a big influence on that wing of the Republican Party. Not surprisingly, he seems pleased with the pounds of flesh they’ve extracted in the new Budget Control Act of 2011.

Armey and I have different ideas of “dumb.” He favors slashing government spending during our Little Depression and also favors a balanced budget amendment that would supposedly compel further slashing. I think those things are time-tested recipes (the times being 1932 and 1937) for worsening a depression. What do the markets think?

The stock market is on track for its eighth straight day of decline (as of 11:55 a.m., the S&P 500 is down 0.5%, and its biggest drop, 2.6%, was yesterday, when the Budget Control Act finally passed). 10-year Treasury bond prices have been rising, and T-bond interest rates falling, over the same span, now down to 2.57%. How to interpret those numbers?

Hard to do, because nobody (as far as I know) takes scientific polls of market participants to ask them why they did what they did. Armey would probably say, as some commentators have, that stocks have tanked because the $2.1 – 2.5 trillion in cuts over a decade aren’t enough. I would say, as have others, that the market is reacting to the dismal state of the economy and to the likelihood that, as basic macroeconomic theory tells us, the spending cuts will make it even more dismal.

What about bonds? The rosy view would be that T-bond prices have improved because the debt-ceiling vote means no default through 2012 and the spending cuts reduce the overall burden of debt. Armey and I might actually agree that the unrosy view is correct: T-bonds are in higher demand because of a worldwide “flight to safety,” as grim economic news causes people to move away from risky, cyclical assets like stocks and toward safe assets like T-bonds. Again, is the grimmer news the “failure” to slash spending more or the weakening economy?

I’m thinking Armey’s quote fits right now, except it’s the budget bloodletters who are dumb and the markets are rationally reacting by anticipating that they will cause further hemorrhaging of the economy.

P.S. At least one market participant agrees. From the Aug. 2 Financial Times:

‘Jim Reid, strategist at Deutsche Bank, . . . has warned the US could be approaching a “1937 moment” – when authorities removed post-Depression stimuli from still-fragile markets and triggered another recession. This risk, he says, has in fact only been magnified in the markets’ eyes by agreement on raising the US debt ceiling.’

(Hat tip: Brad DeLong)