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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If the “mandarins” wanted to do something useful, they could spell out the fact that to the extent the US poses a credit risk, it’s because of the loony-toons who’ve taken over the GOP. But instead, they made noises about the importance of controlling deficits. The mandarins, in otherwords, have thrown in with the rentier class warriors, who are perfectly happy to lie, cheat, and risk economic disaster, if it means they get a shot at totally dismantling the systems erected by LBJ, FDR, and TR to make life in the US a bit fairer and safer for average citizens.

Posted by Auros | Report as abusive

“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.”

this point needs to be repeated until the layman understands it.

Posted by KidDynamite | Report as abusive

You can’t assign all of the power of the default bazooka to the tea party; they constitute only a small minority of the Republican party. The real bazooka is the Republican leadership, which refuses to oppose the tea partiers, because they are pansies who are afraid of being challenged in their primaries. They know the positions of the tea party are suicidal, but they put their party unity and their jobs ahead of what they know is best for the country.

Posted by KenG_CA | Report as abusive

This is a political move. S&P deserved to take a large part of the blame for the banking crisis. Now they are reacting to give themselves more credibility. Plus all the other reasons in the article lol.

Posted by evwarsh | Report as abusive

We should have let the Tea Party pull the trigger, so that they and the world could see exactly what sort of damage their rhetoric and dogma had caused. Then curtly get rid of every last one of them.

Now, we get to span from one crisis to the next, because people (Democrats) think that they did what was the responsible thing…and concede to Tea Party Republican demands.

Posted by GRRR | Report as abusive

The Tea Party may be armed with the bazooka, but was loaded over the past 40 years by members of both parties — and and safety was released during the first 8 years of this century.

Posted by aquacalc | Report as abusive

So they’ve redefined the boiling point of water to 200 degrees. Is that really going to save us any energy? Watch the interest rates as the flight to quality continues. Exactly what alternative value storage vehicle is S&P recommending in lieu of treasury instruments?

Posted by Kaleberg | Report as abusive

There comes a point when the analogy becomes overloaded and bends out of shape. Aquacalc, you’ve reached that point.

Posted by Aesthete | Report as abusive

That the Tea Party organizations were funded by the Koch Brothers – oil billionaires – who forced GOP congressional candidates to sign pledges to never raise taxes – which became prohibitions on repealing tax breaks for billionaires – hello…

We’ve seen the hijacking of the US economy by the likes of the Koch Brothers, via the “Tea Party Patriots,” who, if they knew how unpatriotic they’ve been suckered into being, they would be swallowing the barrels of 9mm pistols right now.

Posted by EricVincent | Report as abusive

Who bet $1 billion that the downgrade would happen?

Posted by tnkamrca | Report as abusive

I’m almost taken aback and the number of people who refuse accountability. This is not the tea party’s fault, nor is it the fault of the progressives’ scapegoats, the Koch Brothers. This is the fault of every one of us who expects more than we can afford. Taxes are too low to afford what we as a society expect, and everybody refuses to pay more. How many who can’t afford health care have no problem supporting their pack-a-day habit? Thank god for the tea party for finally bringing this to the fore front, and kudos to them for trying to do something about it. It’s too bad our inept president and congress don’t have the balls to enact anything of substance.

Also, to the moron trying to blame bush – that was three years ago. We’ve had a decline with obama since he got here. Obama was told this would happen. Obama let this happen. Good god… you’ve got the brains of a congressman.

Posted by ganagati | Report as abusive

Not sure how you reconcile this:
“Taxes are too low to afford what we as a society expect, and everybody refuses to pay more.”

With this:
“Thank god for the tea party for finally bringing this to the fore front, and kudos to them for trying to do something about it.”

Last I heard, the Tea Party was at the forefront of refusing to pay more. I’ve been arguing that we need higher taxes and less spending for a decade now, but as best I can tell the Tea Party only heard half that message.

Posted by TFF | Report as abusive

Um, Felix, the S&P downgrade was delayed because those Bozos who brought us AAA rated Mortgaged Backed Securities made a $2 trillion — that’s $2,000,000,000,000 — error in their initial numbers.

And after Treasury corrected their error for them, still went ahead with the downgrade.

But here you are right. They went ahead because this was a political decision all along — and probably the MD had already left for a long weekend and wasn’t around to respond to phone calls of the form “They caught us out in a $2 trillion mistake. What to do now, boss?” with a response of the form: “You geniuses did what?”

Posted by billyblog | Report as abusive

Does it get worse? Mr. Obama thinks that throwing money at the economy through QE’s and entitlements is better policy (i.e. makes fewer rich people richer) than targeted tax incentives for capital investment. You can’t tax your way out of a deficit. Even Clinton knew that. QE and Obama deficits have widened the rich/poor gap. It caused a run up in commodities. And he’s hadned the banks Trillions and consumers can’t get credit, but Wall Street bonuses are at record levels. Hmm, that seemed to work really well for the rich.

He’d rather give Brazil $3 billion to develop their oil fields so we can buy from them, than to provide Investment Tax Credits for US drilling. He’d rather pay China for processor chips than provide tax incentives for Intel to build plants in the US. And the Republican congress decided to bring us to the brink with crappy rhetoric. They could have said: “we’re going to use every means available, in cooperation with the White House to devise a budget that works prior to the debt ceiling expiring. We know the timing and risks, and want to use this time to do this”. Instead, everyone threatened default. It was a colossal blunder on both sides of the aisle. I’m ashamed. But…where is good tax policy?

Want to fix Medicaire? 80% of Medicaire spending happens in the last 6 months of a person’s life. Want to cut that? There’s a place to do it.

Maybe this downgrade will focus us on what works.

Posted by alwaysdifferent | Report as abusive

The bazookas were not loaded by both parties. They were loaded first by the Reagan defecits. When Clinton managed to reverse that mess, and create a surplus, the GOP again enacted massive tax cuts, which balloone defecits to over $300 billion even in avarage economies.

Then they deregulated the finacial system and let it crash, sending defecits sky high.

Get your facts straight.

Posted by TimConnor | Report as abusive

@TimConnor: You should get your facts straight. The S&P downgraded it mainly based on the “willingness” for the U.S. to pay its debt and whether the government could manage their responsibility in this situation. It wasn’t so much how much debt we had, it was whether the U.S. becomes the “deadbeat dad” and refused to pay the debt. Raising the debt ceiling helps us to pay the debt that has already accrued. S&P downgrade was more of a political decision, that has been well confirmed. So, you are not the one who knows what just happened. Our debt is huge, but it is all about are we going to pay it or on purpose go into default. This is a blame on the Tea Party, because who was the one that said that they will let the country default, and also refused to raise taxes on the wealthier citizens? The Tea Party..the extreme Right. Pres. Obama bent over backwards and wanted the $4 Trillion deal, the Tea Party, with its strangle hold on the Republican leadership, refused! The Democrats said..compromise, the Tea Party says, “NO!”. So, anyone with any intelligence can see that the President was willing to go several extra miles to get a compromise and get it done. It was the freshman who decided it did not want to pay the bills.

Posted by GC3104 | Report as abusive

Please cite a reference for this claim:
“Want to fix Medicaire? 80% of Medicaire spending happens in the last 6 months of a person’s life. Want to cut that?”

This study suggests a VERY different conclusion:
http://content.healthaffairs.org/content  /20/4/188.full
“About one-quarter of Medicare outlays are for the last year of life, unchanged from twenty years ago.”

Posted by TFF | Report as abusive

I have complete and utter disdain for our politicians. We have democrats who resist cuts to entitlement programs, republicans that refuse to increase government revenue, and tea baggers like Ron Paul that are so far removed from what would happen should we abandon the concept of the fiat currency that it makes me cringe to believe how intellectual foul these people are. Tea baggers like Paul think think they can handle the pain of a “real unwind” yet let the chips fall where they may (further bank defaults, higher unemployment, getting fired, no safety net, etc.) and I’d be willing to bet all of those monkey tea bagger that are crying for a purging of the system will be running to government care. They intellectually underestimate the real forces at play when money markets default, banks blow up and equities get cut by 50-75% again.

In the end, we are all screwed. To quote the great Zerohedge (or more appropriately “Fight Club”), “on a long enough time horizon the survival rate for everyone drops to zero”…. Good riddance!

Posted by 1310ticketless | Report as abusive

So what ARE the consequences? I’ve been suggesting that this has been a coordinated effort to return to “higher interest rates” and subsequently “inflation” all along. But to force the issue would be political suicide.

I thought they might actually allow a technical “default” and let the market up the interest rates. Instead, they just simply acted as they normally do and got the downgrade anyway. Now interest rates will rise and no political party’s proposal is to blame. How convenient!

Unfortunately, one name IS attached to this time period in American history. Regardless of his role in the events creating the situation, he will carry the public’s perception of responsibility. Like Mr. Carter, I don’t see a second term for Mr. O. (By the way, in 2008, I was hoping he’d wait until 2012 for his first run and this scenario is EXACTLY why. No matter who held the job post-meltdown, the inevitable pain would be blamed on the resident President.)

Are we really afraid of Stagflation or is it just a great fear-inducing headline? Growth: How many expansion projects or non-essential goods are moving now? How much household or even corporate spending is simply replacing the basic necessities? Inflation: In measured doses, it works well for dealing with outstanding Govt. debt; devalue the currency supporting it. GDP can go up with inflation; static debentures will not.

Now about that jobs problem???
How’s that “free trade” thing working out for ya?
Now that China and India have grown their respective infrastructures and have the capacities to assume global consumption, can we please go back and re-level the playing field? Tariff – an old school solution for your new economy pains. It’s already started but I’d like to see a little more gusto.

But I could be wrong.

Posted by JCnTN | Report as abusive

What Kaleberg said. The money will still be chasing safety. Although the media’s failure to cover the Republican’s fault in this one is troubling, because it promises more trouble ahead.

Posted by Dollared | Report as abusive

congratulations for your fairness, I would have pulled the article considering the downgrade indeed happened few min after the posting.

A downgrade can be soon enough converted into an “upgrade” if a solid will to repay debts is recognized. But is it there now?

Considering that most of our bonds r in the hands of China & Co… perhaps this is just a message for them that the US is getting now poor, wants a discount and lost steam as the world only economic pulling locomotive.

WWII was over more than 60 years ago, is time we quit financing the expansion of all other countries and start thinking more domestically about our well being. Will all those countries be so generous as we had been, now that we need help?

For sure we will pay an immediate steep price: more inflation due to skyrocketing cost of imported goods and commodities. Subsequent economy contraction and consequent worldwide recession r most likely.

Will the politicians have the courage to start supporting domestic manufacturing now? And curb offshore outsourcing and investing?

Wall Street alone and refi our home will probably not pay for food anymore.

Posted by robb1 | Report as abusive

“It must separate the NEEDS of the nation from political WANTS.”

In this case, I’m afraid, the boundary gets fuzzy. Social Security and Medicare are at the root of the problem (especially when you look ahead 30 years), and the programs are already none too generous at the lower end. That doesn’t mean they shouldn’t be cut — but we need to balance the pain of cutting our social safety network against the pain of higher taxes.

I thought that many good proposals came out of the budget commission last year. Large spending cuts AND modest revenue increases, along with a framework along which the income tax system could be rationalized (with lower marginal taxes but fewer deductions).

Instead of voting on that, Congress passed a trillion-dollar spending increase and an extension of the unaffordable Bush tax cuts.

“Until this is done, to give Congress additional revenue would be like giving cocaine to a recovering addict.”

Tax revenues as a proportion of GDP have fallen, not risen, in recent years. Yet spending continues to increase. I hear this line repeatedly, but there is no evidence to support it.

Posted by TFF | Report as abusive

Please allow me to post some facts here:
President Bush in his two terms (2004-2008) led to a debt increase of 6.11 trillion. He started with a debt/GDP ratio of 56.4% and ended with a debt/GDP ratio of 84.2%.
President Obama, in his 2 yrs and 7 months led to a debt increase of 1.65 trillion – but remember the situation he was in. So, why on the Earth, the Republicans BLAME the Democrats for the debt???? Since World war-II all democrat president reduced the debt/GDP ratio and ONY one republican president did that – Eisenhower.

Posted by ForFact | Report as abusive

Please allow me to post some facts here:
President Bush in his two terms (2000-2008) led to a debt increase of 6.11 trillion. He started with a debt/GDP ratio of 56.4% and ended with a debt/GDP ratio of 84.2%.
President Obama, in his 2 yrs and 7 months led to a debt increase of 1.65 trillion – but remember the situation he was in. So, why on the Earth, the Republicans BLAME the Democrats for the debt???? Since World war-II, all democrat presidents reduced the debt/GDP ratio and ONLY one republican president did that – Eisenhower. So, who made the right choices for the Country?
http://en.wikipedia.org/wiki/National_de bt_by_U.S._presidential_terms

Posted by ForFact | Report as abusive

“Your argument that we need to increase taxes as a proportion of GDP”

I didn’t argue anything of the sort. I don’t care whether you increase taxes or slash spending, though I can see reasonable arguments for either (and suspect the American people will eventually support some combination). Unfortunately neither party stands for increasing taxes and neither party stands for real spending cuts.

Instead we have one party that stands for CUTTING taxes, while the other party stands for INCREASING spending. Do I really need to point out where that path leads?

Posted by TFF | Report as abusive

“The government is spending way more than the very considerable income presently available.”

Present federal revenues (2010): $2.2 trillion
Social Security, Medicare, and Defense: $2.0 trillion

My apologies, but it is hard to take you seriously when you talk about balancing the budget WITHOUT reference to Social Security, Medicare, or Defense.

Either you are willing to slash those programs, you are willing to significantly raise taxes, or you are only pretending that you care about a balanced budget.

“That’s the path forward I see as necessary to restore the U.S. AAA rating over time.”

It is the path, but it cannot be achieved without sacrificing some of the sacred cows. Social Security, Medicare, Defense, or higher taxes. The numbers simply don’t add up otherwise.

Posted by TFF | Report as abusive

Sheep, I am largely in agreement with you there, but I see the path a little differently.

I would begin by reverting the tax code to some approximation of what it was under Clinton. Those rates were modestly higher, but they didn’t stifle growth or innovation — and they definitely raised more revenue that is desperately needed for the transition you and I envision. Tax cuts should be the reward for getting the spending and debt under control, NOT the first step in the process.

Social Security can be reformed without seriously endangering anybody’s well-being. The deficit commission last year came up with some suggestions for that. I might collect less than presently promised, but I’d rather collect on a reduced promise than have a promised larger benefit that disintegrates into insolvency before I get a penny. (Right now I don’t count on receiving anything.)

Defense is expensive, and ten years of war would drive any budget into the red. All the more reason to keep the higher tax rates until we can dig out of this hole.

And yes, reconsidering our multitude of government agencies is a good place to start.

Perhaps the 2012 elections will bring us a Congress that takes fiscal sanity seriously? Unfortunately the current version is incapable of agreeing on anything that might reduce the deficit.

Posted by TFF | Report as abusive

“The process now necessary is essentially unprecedented and every bureaucrat on the hill will be screaming bloody murder. Washington will NOT have a Merry Christmas.”

I waver between “wholehearted agreement” and “I’ll believe it when I see it”. Enjoy!

Posted by TFF | Report as abusive