23 April, 2011

About That S&P Report

I was going to write a nice long post about it, but really I can point you to two articles that tell you everything you need to know.

Keith Hennessey breaks down the report, and explains exactly what S&P is trying to say to the United States.

For those of you that won’t click through, here’s a summary:

Let’s tease this apart.  S&P describes three distinct but related risks:

  1. The risk of no agreement on a medium-term fiscal strategy before the 2012 election;
  2. The risk that, if there is an agreement, it will be phased in too slowly;
  3. The risk that delay plus a slow phase-in allows enough time for future policymakers to partially undo an agreement.

I think all three are valid concerns, and I share their skepticism.

They describe other short-term fiscal risks that worry them as well:

  • the risk of further financial bailouts;
  • the potential cost of “relaunching” Fannie Mae and Freddie Mac, which they estimate at “as much as 3.5% of GDP (!!!);
  • the risk of losses on federal loans (they single out student loans).

The first bullet here is scary, and they emphasize it: “Most importantly, we believe the risks from the U.S. financial sector are higher than we considered them to be before 2008.”


There is a moderate chance (1 in 3) of an incremental, slightly bigger (maybe $300B – $500B over 10 years) deficit reduction deal before the 2012 election. The President would trumpet such a deal as a good first step, but it appears this would fall far short of what S&P says is needed.

Given the President’s apparent budget strategy, there is at the moment a vanishingly small chance of a big medium-term or long-term deal like that described by S&P as necessary to avoid a possible downgrade, ($3-4 trillion over 10 years, with even bigger long-term changes to Social Security, Medicare, and Medicaid).

Really, read the whole thing. This is the best article you’ll see about what the report actually means. It’s non-partisan and hard hitting.

The second article is by Megan McArdle of the Atlantic. You need to subscribe to both of these people’s posts. She’s also quite non-partisan and has often called for higher taxes.

This is why I am so steadfastly unconvinced by people who point to our low interest rates as evidence that the market thinks it's safe to borrow.  When higher real interest rates come, they will not be a timely signal of problems ahead unless we change course--they will be the problem


Of course, this warning applies equally to the people who think that demagoguing the debt ceiling is a fine way to force Congress to fix things (on their terms).  Shutting down the government, or mucking around with the debt ceiling, doesn't help avert a crisis: it is the crisis.  Or rather, it risks triggering precisely the crisis of confidence that we want to avoid. 


The US debt problems are large, and they will be painful to solve.  But they are not intractably large or painful.  It is our bitter, partisan politics--and our own willingness to compromise, or even face reality--that is putting us at the most risk.

As I said above about Hennessey, read the whole thing.

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