The downgrade is utterly ridiculous and the ratings agencies are going well beyond their remit now.

Basically the job of ratings agencies is to assess a product in the market and rate its safety as an investment.

With government debt this simply means “what’s the likelihood of a default?”

The likelihood of the USA defaulting is zero. It is genuinely implausible that a default will happen.

The political row that took place over the last few months shows this. With an election coming, with a divisive president in the White House, and with a radical wing of republicanism capitalising on their party’s recent structural weakness – the Senate still agreed to raise the debt ceiling.

So what situation would ever lead to a default?

Just like Moody’s campaigning for the Tories in the 2010 election by talking up a downgrade (despite UK bills being long term, low cost, and debt being relatively low) – this is just S&P campaigning for the republicans.

@1

So you don’t think the US will ever default? You don’t think that there is a chance that so much debt will be run up that it is impossible to repay?

Is this because you think the US can always print its way out of default? That is the only reason for saying that there is a zero chance of default and a scenario of ever more money printing would have its own consequences.

margin
Do suspect a political motive.
It does seem to me that the US was in worst economic situation in 2008 or at least as bad.

I agree with Tyler Cowen.

” 4. As a simple rule of thumb, if at this point, in response to this news, a commentator attacks the ratings agencies for their previous mistakes and stupid, corrupt behavior, it’s a sign the commentator is trying to muddy the broader issues at stake. Such commentators may well be correct in their criticisms, but probably they are not facing up to their recent mistakes and seeking to shift the blame. Watch out for this. ”

Is the downgrade of the U.S. justified? Yes. The U.S. can currently borrow in the markets at historically low yields. However, the U.S. fiscal problems are long term and a gridlocked dysfunctional political system shows no signs of being able to address the problems. Triple A nations do not put their sovereign debt on the table as a bargaining chip. They deserve to be downgraded for that alone. One of their main political parties is ideologically opposed to closing any of their deficit through raising taxes. Not a serious position and they deserve also to be be downgraded for that magical thinking.

Until the U.S. gets a grip in containing the long term rise in healthcare costs and defence expenditures, they are not seriously addressing their problems. That specifically is why the recent debt ceiling fix was not serious. A deal to contain costs and raise revenue was what was required.

” Though if the markets don’t really react to the news, it would undermine S&P’s credibility, surely? ”

Not really. The markets gyrated yesterday as rumours circulated about the downgrade and the DOW ended up on the day. The information is now in the price. Only marginal buyers who are only allowed to buy triple A paper are going to stop buying US Treasuries. Moreover, even for them it requires two rating agencies to downgrade. The U.S. political gridlock and fiscal problems are hardly new information so it will not dramatically increase the U.S. borrowing costs. The U.S. problems are not in the immediate short term, and there is simply nowhere else to go compared to the U.S. Treasury market. However, eventually the bond market will hold the politicians feet to the fire and force them to address their problems.

Richard W
True but the situation was as bad in 2008.
Why no decision then ?

Fungus

What a ridiculous strawman suggestion.

There is never no chance of default – but there is such a tiny chance in comparison to almost any other form of investment in the world – that if US Treasury Bills don’t carry the highest rating available, nothing can possibly qualify for the highest rating.

Richard

There are a couple of flaws in your analysis – though much of it is spot on.

You are absolutely right that the downgrade is a response to factors, not a trigger for them – and those factors have been priced in to the market already, as, to an extent, has the downgrade itself (though in reality the impact of downgrades at that level are often relatively slight)

Likewise you are right that the Republican policy agenda is so utterly unrealistic, and their tactics so outrageous, that the USA needs to look seriously at the direction its country is heading in.

But these do not themselves justify a debt downgrade. (Not least because the debt ceiling was raised despite the idiocy of the republican extremists – suggesting the system is actually pretty robust when pressed).

Importantly though it is worth adding that the debt ceiling deal is something that the USA has been through about 20 times in 30 years. At no point has anyone suggested that debt ceiling talks would ever be the right forum for the incremental adjustments that the USA must make to overcome structural weaknesses in its economy. Likewise while rising healthcare costs are an issue, much of this is private sector and so less of public finance liability than in Europe.

As such there is no reason why such negotiations should factor in the rating at the moment. And no one is even claiming that the downgrade happening now is coincidence and actually it reflects long term structral issues.

@6

Then why say “the likelihood of the US defaulting is zero” ?

And I disagree with your assessment that there is a tiny chance compared to any other investment in the world. That was true pre 2008, but not anymore.

Fungus

I apologise for my predaliction for hyperbole – you are right – I should have said it was basically zero.

Bt you are wrong about the chance of defaulting generally. The USA is a million miles from facing a default.

The US could default, but only as a political decision, not an economic one. The current debacle in the US is an entirely politically-confected waste of time.

Why should anybody care what the ratings agencies say – they’ve downgraded Japan for many years, and they have no problems in selling bonds at a low rate.

What is more sinister is that S&P said that they would downgrade unless $nnn trillion cuts were made. So who is in charge of the US economy? The people? The government? Or the ratings agencies?

It’s interesting that throughout this crisis that there had been a missive emphasis on the rates of Eurozone bonds – if they go above 6%, then the end is nigh. Yet nobody is talking about the rates on US bonds, because they have hardly moved. I predict the same on Monday.

@9

I agree that the US is not going to default in the immediate future, but I believe it deserves a downgrade of one level – it is still very high quality debt. It is not like it has been downgeaded to anywhere near junk.

Bill Goss, manager of PIMCO has dumped all of his US treasury holdings.

Bill Goss may regret that. Ironically many have got rich betting against changes in ratings. The long term status of US debt is still strong, but they will be below value on a short term shock.

But you should remember………

“It was S&P that had Lehman Brothers rated AAA just a month before they went bankrupt.

It was S&P that rated AIG’s credit default swaps as rock solid investments

It was S&P that admitted to making a $2 trillion accounting error (remember, playing with numbers is their core business and reason for being) in advance of the downgrade of U.S. debt.

A downgrade in U.S. debt means functionally that U.S. treasury bills are, in S&P’s oh-so-wise opinion, less trustworthy and a greater credit risk to investors. This comes only a day after investors fled the DOW and S&P500 into the safe and waiting hands of…you guessed it: U.S. treasuries. The same treasuries that S&P suddenly finds a more dangerous buy. So what does that say about the stock market, and the S&P500? Perhaps S&P might wish to re-evaluate the credibility of its own market index.

None of the other ratings agencies are taking the drastic step that S&P has. S&P is all alone in their move to downgrade U.S. credit.

When all is said and done, U.S. treasuries are still the safest investment in the world, and it would take either an idiot or someone with a strong political agenda to contend otherwise.”

” its more to do with political gridlock in the United States government than the total size of the debt”

No, the political gridlock is making the situation worse, but it’s not “more” important to the downgrade than the debt and deficit. The UK would have been downgraded if the Coalition had not put forward a convincing deficit reduction strategy. And the UK may yet be downgraded if a global recession derails the deficit reduction strategy.

@14 – No, the UK *will* be downgraded because of flatline growth.

Playing to the market means you lose, one way or another.

@13 Sally

I know I shouldn’t bother, but I’ll respond.

“This comes only a day after investors fled the DOW and S&P500 into the safe and waiting hands of…you guessed it: U.S. treasuries. The same treasuries that S&P suddenly finds a more dangerous buy. So what does that say about the stock market, and the S&P500? Perhaps S&P might wish to re-evaluate the credibility of its own market index.”

What it says is that investors believe equities are overvalued. Why does this mean S&P needs to revaluate the credibility of its own index??? The index is perfectly credible – it does exactly what it is supposed to.

“When all is said and done, U.S. treasuries are still the safest investment in the world, and it would take either an idiot or someone with a strong political agenda to contend otherwise”

Really? So you think it is safer than say Norwegian or Austalian Government debt? Or gold? Interesting opinion.

@ 7. Margin4error

Nearly all sides agree that the U.S. debt trajectory is not in the long term sustainable. Therefore, from a rating perspective, they would want to consider what are the politicians going to about it. The indication is that they can’t work together and get common agreement to change the trajectory. These are not insoluble problems, if the politicians were willing they could easily come up with a credible long term plan. The rating agencies are not expecting them to slash and burn this year or next etc. Just some indication that the U.S. Congress are serious and at some level a credible plan must include some tax rises. When one side of the aisle consider raising a cent in tax is akin to tyranny, they have departed from the reality community and deserve to be downgraded.

The UK public finances like the U.S. are not sustainable. Yet, the difference is there is broad political agreement that the deficit must be eliminated. The parties argue over the detail and the timescale of reducing spending, and the share that tax raising should play in balancing the books. However, amongst the main political parties the differences are in reality minor. Nobody in the UK was screeching abut tyranny when the coalition government raised taxes, and a quarter of the consolidation is coming from tax. I would imagine that all those things matter from a rating perspective.

No country that issues debt denominated in its own currency ever needs to default. Therefore, a U.S. default would always be a political decision rather than an economic one. De facto default through higher than expected inflation do not count as a formal default. The rating agencies do not consider inflation as that is assumed to be embedded in the bond coupon.

And lo, the US Treasury yields fall to their lowest level since last October.

There is a good dismemberment of S&P here: http://fivethirtyeight.blogs.nytimes.com/2011/08/08/why-s-p-s-ratings-are-substandard-and-porous

The AAA rating for the US has been baffling me, especially these last five years. If creditors’ money (not least Asian and China’s one) stops flowing in, the US should cut some of its budgets by at least 20% (in defence spending, for instance?) to redeem parts of foreign loans!

You don’t need to be a rating office to cite at least a dozen economies and financial systems and sectors that are better managed than the US one: Germany, Sweden, Singapore, Canada, Switzerland, Norway, Hong Kong (and China? Why not?), and a few others.
You’ll tell me it’s not their role to “judge” management. Whew, what a relief! Why then do almost all today’s politicians , who are supposed to manage public debt too, take ratings as trutths and are ready to change their behaviour just because of the latest announcement. Obama’s reaction is not to his… credit.