Making minimal sense out of debt and credit ratings

In the first week of August, the U.S. raised the debt ceiling, cut trillions from the budget, and saw its/our credit rating downgraded from AAA to AA — sort of. “Sort of” is the operative characterization for all of these events, despite their high-profile news treatment during the dog days of summer. (August’s more traditional dog-days stories include a polar bear attack that killed one camper and injured others in Norway, a St. Paul man, who didn’t have time to use his bear spray before grizzly bear attack in Glacier National Park, and an end to a ban on dogs in Jiangmen, China.)

Congress and the debt ceiling first: if you tired of the non-stop, 24/7 coverage in July, you are in good company. With the Grand Old Party transformed into a Just Say No (to everything) caricature of genuine conservatism, Obama led the Democrats in either a Solomonic compromise to save the country or a dastardly betrayal of principle — take your pick. Jonathan Chaitt in TNR summed it up well:

But if you think Obama’s negotiating strength played zero role here, ask yourself why no previous president has ever been jacked up over a debt ceiling hike before. Indeed, why have Republicans successfully adopted a tactic I don’t believe either party has ever used before — forcing concessions by threatening consequences that they themselves agree would be disastrous to the country? It’s common for parties to support policy changes the opposition thinks will destroy the economy, but it’s highly unusual to threaten to do something your own side says would have such a result. That’s a negotiating tactic used by kidnappers and terrorists but rarely by political parties vying for the support of the public they are threatening to harm.

Part of the Republican “negotiating” stance on the debt ceiling increase was the threat that the U.S. credit rating would be downgraded if the country defaulted. So the debt ceiling was raised, and Standard & Poor’s promptly downgraded the U.S. credit rating from AAA to AA. What gives?

First, Standard & Poor’s is one of three major credit rating agencies, the other two being Moody’s and Fitch, both of whom still give the United States a triple-A rating. And S&P is taking a lot of heat because its initial downgrade was based on a $2 trillion mistake in its numbers. Their response, as they acknowledged the error but kept the downgrade in place, was something along the lines of, “Oh, piffle, what’s $2 trillion these days, anyway?”

It’s also interesting to note that the national deficit is not the primary reason for the downgrade. Rather, as James Kwak succinctly puts it, “So, Standard and Poor’s went ahead and downgraded the United States yesterday, apparently because we have a dysfunctional political system. Who knew?”

Second, downgrading the credit rating probably won’t make much difference in interest rates, according to NPR Planet Money blogger Jacob Goldstein

When other countries were downgraded from AAA to AA, the effect was minimal in most cases, according to this this report from AllianceBernstein. Japan, for cexample, was downgraded in 2009, to little effect. When Canada was downgraded in 1994, its interest rates briefly went up by half a percentage point — but two months later, rates had come back down to where they were before the downgrade. (Canada later regained its AAA rating, by the way.)

Paul Krugman makes a frontal attack on S&P, noting (not for the first time) that S&P has a less-than-stellar record for good financial judgment, having given Lehman Brothers high marks just before its 2008 collapse.

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

So this is an outrage — not because America is A-OK, but because these people are in no position to pass judgment.

I’m writing this on Sunday, August 7, and the big question right now is what will happen when the markets open tomorrow, especially after last Thursday’s precipitous slide. But even that slide probably was overstated. The Dow dropped 513 points on August 4, and then recovered only 61 points on August 5. That brought it to 11,445.

Put the numbers in perspective. At its highest point in 2007, the Dow was just above 14,000. At the depth of the recession in 2009, it was below 7,000. By May, it had recovered to something like 12,800, before dropping down below 12,000 in June, and then zooming up above 12,600 in early July. Now the market is sliding down. According to the New York Times, the market fell about ten percent in the past two weeks, but, “The last time the market was in a correction was last summer, when it fell 16 percent before recovering.”

So are we looking to a continuing “correction” to something below 11,000, and a recovery in September of 2011, similar to that of 2010? Or are we facing a double-dip recession that could plunge down to 2009 levels?

I don’t know. I don’t think anyone does. Paul Krugman, whose analysis I trust more than most, is not optimistic. So I have bookmarked The Conscience of a Liberal (Krugman) Baseline Scenario (James Kwak and Simon Johnson) and made a resolution to follow them more closely for insight into whatever the year ahead brings.