Why the S&P downgrade was delayed

By Felix Salmon
August 5, 2011

The S&P downgrade noise out of Washington right now is decidedly unclear; most of it seems to be confined to Twitter, with this being one of the few exceptions. But the general understanding is that S&P decided to downgrade the US, told the White House, got serious pushback, and ultimately — for the time being — did nothing.

There are three points worth making here, even in ignorance of the details of what went on behind the scenes today.

Firstly, talk of debt-to-GDP ratios and the like is a distraction. You can gussy up your downgrade rationale with as many numbers as you like, but at heart it’s a political decision, not an econometric one.

Secondly, the US does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default. The Tea Party is fully cognizant that it has been given a bazooka, and it’s just itching to pull the trigger. There’s no good reason to believe that won’t happen at some point.

Finally, it’s impossible to view any S&P downgrade without at the same time considering the highly fraught and complex relationship between the US government and the ratings agencies. The ratings agencies are reliant on the US government in many ways, and would be ill-advised to needlessly annoy the powers that be. On the other hand, the government has been criticizing them harshly for failing to downgrade mortgage-backed securities even when they could see that there were serious credit concerns. So by that measure they have to downgrade the US: the default concerns we saw during the debt-ceiling debate were real and can’t be ignored.

I wouldn’t be at all surprised to learn that substantially all of today’s market action was attributable to the status of the S&P downgrade. Stocks opened higher on the strength of a decent jobs report, fell off when it looked as though the downgrade was coming, and then rallied back when it became clear that it wasn’t, ultimately ending the day flat.

If that’s the case, then we can probably expect an immediate sell-off of no more than a few hundred points on the Dow if and when the S&P downgrade finally arrives.

But that won’t be the end of the story, by any means. Alan Taylor and Christopher Meissner have a long new paper out looking at the value of America’s “exorbitant privilege” — they put it at roughly 1% of GDP and falling. That’s $150 billion a year or so. An S&P downgrade would surely accelerate the decline, by some unknown amount.

Do the mandarins at S&P — people who, it seems, can’t even get basic macro sums right — really want to cost the US economy tens of billions of dollars a year by downgrading the country’s debt and causing all manner of potential market mischief as a result? I can’t see that there’s much in it for them, even if a downgrade is the intellectually honest thing to do.

Eventually, we can be sure that the US will be downgraded. But this is a bit like the banks’ rearguard action on debit interchange: simply delaying the inevitable is worth billions to the government. So expect as many delaying tactics as Treasury can lay its hands on. You can be sure that everybody in the sovereign group at S&P is under enormous pressure right now. They’re going to take their time before taking this essentially irrevocable step.

Update: This was, obviously, posted about half an hour too early: S&P went ahead and downgraded the US after all. It’s not a surprising move, but it’s seismic all the same. The immediate consequences will be significant; the long-term consequences will be orders of magnitude larger. And I do think it’s fair to pin the lion’s share of the blame on the existence of the debt ceiling.

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