By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

The Standard & Poor’s downgrade of the United States couldn’t have come at a much better time. Markets may be wobbly, but interest rates are at historic lows and buyers of U.S. debt are plentiful as the world braces for another economic slowdown. There may be some initial turbulence when investors return on Monday, but if the rating agency waited until markets acted first the consequences would be far more severe.

After all, the rating agency’s decision shouldn’t have come as a shock. S&P made no secret of what it expected from the debt ceiling brawl that put the full faith and credit of the largest debtor nation in the world on the line. It wanted roughly $4 trillion in deficit reduction and a credible plan to fix longer-term deficit problems. It got neither.

Yet despite expectations of a downgrade, during last week’s financial market rout investors plowed into U.S. Treasuries. Ten-year yields fell as low as 2.34 percent. With few alternatives at their disposal, it will take more than the downgrade by one closely-watched rating firm to change America’s go-to status for investors in times of trouble.

Anyway, the fact that Fitch Ratings and Moody’s Investors Service affirmed their AAA ratings also should keep a lid on any forced selling in credit markets as investors with mandates to hold only top-rated debt can lean on the opinions of the other two raters.

Moreover, it’s hard to see an alternative to S&P’s verdict having much of a salutary effect on markets. For starters, affirming its AAA rating, after it had aggressively drawn its line in the sand, would have destroyed S&P credibility with investors — far more than the $2 trillion error it initially made in its assumptions.

Even worse, it would have sent a signal to Washington that its political shenanigans come without consequences. It’s better for S&P to call out the failings of America’s leaders before global investors do. The euro zone’s woes serve as a cautionary tale of how swiftly investors lose confidence — and how difficult it is to regain.

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Thursday’s market plunge reflects, as much as anything, an ugly political paralysis. This phenomenon, rather than any particular headline, seems to have freaked out investors, sending U.S. stocks down around 4 percent at one point, Treasury yields below 2.5 percent, oil under $90 a barrel and even gold off 0.5 percent. Politicians’ brinksmanship in Europe and the United States makes for great theater, but it has done little to resolve what most troubles the global economy: too much debt and no clear plan to pay it off.

Take Uncle Sam. Some lawmakers seemed willing to risk a self-inflicted catastrophic default. Yet the last minute agreement did nothing to address the long-term healthcare and Social Security burden — by far the biggest danger to the nation’s finances longer-term. The $2.4 trillion in hoped-for but nebulous spending cuts falls short of the $4 trillion needed to stabilize the U.S. debt-to-GDP ratio. And the deal ensures that the clearly slowing pace of economic growth can’t be tackled with fiscal stimulus.

Europe, meanwhile, still looks lost in the weeds of its much more real and immediate debt crisis. The region has been trying to set things right for nearly two years since Greece’s oversized debt load first appeared in the market’s crosshairs. A series of EU-wide rescue packages may have been political achievements of sorts, but their failure to address the problem fully has left peripheral nations vulnerable to bond market sharks, with Italy the latest to feel their bite. Calls for a bigger European rescue fund and the European Central Bank’s decision to intervene in markets again show the political classes floundering.

Predictably, many investors are holding out hope that central banks will ride to the rescue, as they have for the last four years, with further monetary stimulus. But it’s no surprise their limited tools are no longer right for the job. Flooding the market with more cheap money surely can’t be the right fix when the Bank of New York, for one, is now charging big depositors a fee to park cash in its vaults.

What’s needed is a genuine effort to reduce debt, not just delay repayment one more time, as with the latest Greek bailout. Unfortunately that means making unpalatable choices, like opting for austerity and even tax hikes, at least temporarily. While the West’s leaders instead flail and fudge the numbers, it’s no wonder if investors lose faith.

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

A year after the Dodd-Frank Act, the $10.5 trillion U.S. mortgage market is still in limbo. One big reason is that the law scarcely touches Fannie Mae, Freddie Mac and the Federal Housing Authority — the collection of government-run lenders that these days dominate the home loan market.

The consequences of lax mortgage lending were central to the 2008 financial crisis that Dodd-Frank was intended to make unrepeatable. But rather than tackle the huge and highly political issue of Fannie, Freddie and the FHA, the law is narrowly focused on one part of the market. That’s the private-label mortgage-backed securities area, dormant since the crisis but the source of more than $3 trillion worth of mortgage bonds between 2002 and 2007.

The most significant new rule could require private-sector financial institutions to hold at least 5 percent of securities they create by repackaging loans. Giving them some incentive to ensure the securities are creditworthy isn’t a bad idea. But it reinforces the notion that the private sector is at a competitive disadvantage to government lenders if and when it returns to the MBS business. That’s because Fannie, Freddie and other government agencies would be exempt from this requirement logically so, since their credit, which stands behind their mortgage securities, is in turn backed by Uncle Sam’s.

The risk retention rule plays into another Dodd-Frank initiative: the creation of new standards for safe-as-houses home loans known as qualified residential mortgages. QRMs, in which the proposal is that homeowners must put 20 percent down, among other criteria, would be exempt from risk retention requirements. Banks, in addition to real estate lobbyists and consumer groups, want the standards to be looser since mortgages that don’t qualify could be costlier, by up to a percentage point on interest by one estimate. That hardly seems catastrophic for borrowers when 30-year mortgage rates are as low as 4.5 percent. But it’s easy to see the banks’ point when federally backed housing agencies sometimes allow homeowners to borrow 96.5 percent of the value of their homes.

In short, the reform effort so far seems to have widened the gap between public and private sector mortgage lending, making it harder for the latter to re-establish itself and entrenching the cost, and risk, to taxpayers from the former. Congress and regulators need to assess housing finance as one market. Until the hulking government mortgage lenders’ future is mapped out, the worthy goals of Dodd-Frank don’t mean much.

By Agnes T. Crane and Christopher Swann The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

The latest U.S. jobs report should give fiscal hawks pause. With economists expecting employment to rise by a modest 100,000 in June, the piddling increase of 18,000 proved a bitter blow for a country amid the throes of an austerity debate.

Last month’s gloom was compounded by a dip in wages. And more than 250,000 people gave up the job hunt altogether. At this rate, it would take over three decades to recover the 7 million jobs lost during the recession.

At the root of the problem is the reluctance of private firms to hire, despite a strong rebound in profits since the financial crisis. The 57,000 positions they added to payrolls in June was less than half of expectations. And a fall in temporary positions and the number of hours worked may point to further weakness in the months to come.

Still the continued bleed of public sector jobs — 39,000 more last month — is also proving a powerful drag. Over the past year, constrained federal, state and local governments have dumped 659,000 jobs. That has offset more than a third of the gains by businesses small and large. This should not be lost on lawmakers in Washington, who are in full combat mode over budget deficits.

Chronic shortfalls have taken their toll. State and local authorities have already been forced to make painful cuts, including in education, to offset falling revenue and the end of Uncle Sam’s generous stimulus packages. Now it’s the federal government’s turn.

Democrats and Republicans are fiercely debating the best way to cut as much as $4 trillion from the budget over the next decade. If tax increases are off the table because of their potential to inflict further pain on the job market, deep spending cuts will be the only way to narrow the deficit gap.

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

For the clearest sign yet that U.S. housing reform is floundering, just take a look at the latest proposal. Two lawmakers, with industry lobbyists in tow, are heralding a union of Fannie Mae and Freddie Mac, which would leave the government still in charge. Even more than other ideas floating around, it would preserve the status quo. It only goes to show just how weak the political will is for a real fix.

The full details are still forthcoming but early reports hardly inspire much confidence. The newly created Frannie, as it were, would look a lot like the old government-sponsored entity framework. It would buy mortgages, package them into tradable bonds and, most significantly, come with a government guarantee. After pumping more than $160 billion into Fannie and Freddie, Uncle Sam should be seriously questioning guarantees, not embracing them.

Since being seized by the government three years ago, Fannie and Freddie have become even more important to U.S. housing. By propping up the market, this has terrified the real estate industry and consumer groups into thinking the disappearance of the GSEs would herald yet another downturn in home prices. That fear isn’t without merit. Fannie and Freddie, together with the Federal Housing Administration, are guaranteeing roughly nine out of 10 new mortgages and back roughly half the $10.6 trillion market.

But the debate needs to be far less myopic. Wringing out excesses, for one, will mean demand for home loans won’t return to the go-go days of yesteryear. That means the private sector could eventually shoulder a bigger share. Proposals should pave the wave for transferring risk back to where it belongs — the homeowner, the lender and other investors. Uncle Sam has already done more than his fair share.

The duration of the debate over Fannie and Freddie makes the path of least resistance — especially for politicians worried about re-election and other front-burner issuers like the deficit — ever more appealing. The proposal, from Representatives Gary Miller of California and Carolyn McCarthy of New York, crystallizes just what can happen when a crisis fades from view and indecision persists for too long. Few expect Congress to enact any legislation on U.S. housing reform until at least 2013 anyway. Sadly, that should make selling the status quo even easier.

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

U.S. lawmakers don’t like subsidizing municipal project financing. Last year they ended the Build America Bonds program that did just that. Yet the continuing federal tax break on state and local debt is a subsidy by another name. Getting rid of it could hit smaller borrowers — but would create a more efficient, transparent market.

No one starting afresh would design today’s municipal bond market. It was born of a 19th-century court ruling that made its way into the tax code and persists there, even though the courts have since changed their minds. Today, it’s a $2.9 trillion behemoth where an estimated 50,000 issuers finance things like schools, sewer treatment plants and public transport systems.

Large institutional investors tend to steer clear of munis because they’re after yield, not tax breaks. Municipal debt traditionally trades at lower yields than comparable U.S. Treasuries because individual investors pay less tax on the interest. But without the liquidity that comes with big players, even a smallish exodus by the sector’s mainly retail investors can trigger volatile swings.

Making munis taxable would bring in more of the big guns. The aborted BAB program, which subsidized borrowers rather than investors, proved that. Their firepower would help make the market more transparent as well as more liquid. After all, these investors aren’t likely to be satisfied with the thin disclosure that’s all too common. And the federal government would end up getting a bit more tax revenue.

Big and regular issuers like California wouldn’t have too much difficulty adjusting to a taxable market. Morgan Stanley estimates that a generic, A-rated state issuer could end up paying just 0.04 percentage point more of its budget on debt servicing over the next 10 years if it sold taxable debt.

Smaller borrowers — say in the $10 million range — would struggle more. They’ve traditionally relied on local bond buyers attracted by interest income that’s exempt from both state and federal taxes. With part of that benefit gone, borrowing won’t be so easy.

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

The Federal Reserve’s $600 billion Treasury bond-buying program, known as QE2, is ending. At least a few investors are ready for QE3, despite no hint of it from the U.S. central bank. Though some in the markets might want it, further monetary stimulus is a bad idea.

PIMCO’s Bill Gross has even suggested the Fed could cap longer-term interest rates than the overnight rate it traditionally targets and currently aims to keep in the zero to 0.25 percent range. That sounds like the talk is moving into absurdist territory — except that Fed Chairman Ben Bernanke staked out the ground nearly a decade ago.

Gross has taken up the cause using his Twitter account. He has said over the last week that caps on longer-dated yields — two years, say — could become a reality. The United States did something like that in the 1940s. And Bernanke, in a 2002 speech, said the central bank could suppress yields by “committing to unlimited purchases of securities up to two years from maturity.”

But today’s realities make such a move unlikely. The Fed now holds a massive $2.8 trillion of assets, up from around $900 billion in August 2008. That’s already a sore point inside the Fed — let alone outside, especially among critical Republican lawmakers. The latest round of quantitative easing may have helped boost stock markets and confidence, but it’s hard to conclude it fueled economic growth or the housing market, the U.S. economy’s biggest drag. There are costs to lax monetary policy. The Fed saw the benefits of QE2 as outweighing those, but that’s a harder case to make each time.

Committing the Fed to unlimited further expansion of its balance sheet could provoke an internal revolt and would certainly trigger political attempts to end the institution’s cherished independence. Even if the economy worsens, Bernanke would have a tough time selling more easing.

With inflation at least temporarily rising, he isn’t trying to do that right now. Investors need to recognize how little more the Fed can do. As the bank’s officials have noted, fiscal stimulus has a far more direct effect — though that, too, would offer diminishing returns even if it didn’t look politically impossible. It’s time for markets to tough out the sluggish recovery on their own.

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

The U.S. government wants to wind down Fannie Mae and Freddie Mac. But the task is getting bigger, not smaller. Toxic and hard-to-sell mortgage loans — more than $900 billion of them so far — increasingly dominate the two housing finance giants’ balance sheets.

The numbers from the Federal Housing Finance Agency, which regulates Fannie and Freddie, are astounding. In a 150-page report shipped to Congress last week, the FHFA said 65 percent of Fannie’s $789 billion balance sheet at the end of last year was accounted for by illiquid loans. Freddie’s hard-to-trade assets represented more than half of its $697 billion portfolio. The sub-category of distressed assets increased nearly three-fold to $367 billion from a year earlier between the two firms as they bought back severely delinquent loans from the pools underlying mortgage-backed bonds they guarantee.

The regulator expects the proportion of illiquid debt to increase further this year. Barclays Capital estimates the two government-sponsored enterprises are yanking about $10 billion of loans a month out of mortgage-backed bonds. Meanwhile, Fannie and Freddie are required by the terms of their government rescue to reduce the overall size of their balance sheets by 10 percent a year. With toxic and hard-to-sell loans piling up, they have to sell or run off good assets. The trend could continue until the still queasy housing market stabilizes. The GSEs could eventually run out of easily traded assets to sell.

This pattern makes winding down Fannie and Freddie even harder than it otherwise would be. Illiquid investments are difficult to hedge and costly to hold if funding costs rise. And getting rid of their huge holdings — which the two companies will eventually have to do — is sure to be a challenge. Bear in mind the Federal Reserve’s experience with the toxic assets it bought from American International Group AIG.N. The central bank has sold only one-third of the roughly $30 billion of paper it acquired from the insurer, but there are already indications that investors have indigestion.

It’s another reminder that Uncle Sam’s GSE problem is festering. The longer Fannie and Freddie remain sick and their treatment is undecided, the more unpleasant — or, worse, ineffective — the results could be.