Standard & Poor's U.S. Downgrade response

Standard & Poor’s U.S. Downgrade Response on 8-26-2011

The writer of this discussion didn't plan to do any more writings as it looked a lot like all talks but no action. Yet, the writer didn't see the unprecedented Standard & Poor's U.S. Downgrade was coming because the bill had passed. Perhaps many people saw that. Bloomberg News on August 6, 2011 wrote an article about the Downgrade: "U.S. Loses AAA Credit Rating as Standard & Poor’s Slams Debt Levels, Political Process." The Downgrade of 'AAA' long-term rating touched the political process and therefore any discussions regarding the Downgrade are deemed political and they shall be protected by the First Amendment. The drafters of the Constitution believed that through the free and open exchange of ideas the truth, sooner or later, would be exposed. Once the citizens know the true, they are able to make more intelligent decisions. The core of First Amendment clearly is the protection of freedom of political expression. There are a lot of people more qualified than the writer to discuss United States political system and process. Also this discussion is not relevant to the operation of this web site at all. Considered the economic condition, the writer decided to give it a try.

The Downgrade triggered a global sell-off and caused the Dow Jones index to tumble. The write believes the consumer confidence took a big hit because of the big swing. This event suggests that there are all kinds of confidences, not just consumer confidence, may help the economy. If a negative effect to Confidence will have a negative impact to the economy, the writer believes the opposite should also be true. One area to look at Confidence is uncertainty. While the third and the fourth largest economies in eurozone still are having debt issues, it appears that it will take quite a while before they can fix the problems. Idea similar to stress tests which project the impact of those countries' problems toward U.S. GDP or financial sectors may be helpful if they have favorable results. Government and business relation is another factor. If business is lack of faith toward the government or the political process, it may have a detrimental effect to the economy. Maybe government and business relation should be amended if it has not already done so and if it is politically possible. Maintaining hostility serves no purpose. The government may ask businesses to help identify areas of uncertainty and remove it if it is politically possible. The government needs all the help that it can get and we are all indeed in the same boat. Furthermore, the way that the Congressmen or Congresswomen agree or disagree is as important as the agree or disagree itself because it can be interpreted as the degree of political risk. Here are the rules of thumb suggested by the writer. If the GDP growth is around 4% or more, the economy is likely to expand and significant job increase will happen and the political risk is less of a factor. The politicians can yell at each others if it is how they behave. If the GDP growth is 2% or less, U.S. will be likely to lose jobs because of automation, productivity increase and other factors. Political risk is more of a factor. The politicians should hug each others even if it is not how they feel. If the GDP growth is 3% or less, job creation will be in a slow pace. The politicians can give each others hostile looks if they choose to, but no more.

Federal Reserve uses rate hike to combat inflation (stable prices). In most cases, it affects the growth rate. The writer looked at the effects of the Downgrade, and found that the effect was a lot similar to the rate hike from Federal Reserve. It was said that the threat of rate hike was as effective as the rate hike itself. President Obama has said a rating cut may hurt the broader economy by increasing consumer borrowing costs tied to Treasury rates. The threat of further downgrade is real. The writer believes such threat is as bad as the Downgrade itself. Standard & Poor’s has power comparable to the government but it is not a government branch. Government can not take away the citizen's property without Due Process. However, Standard & Poor’s can and did. The property in question is the 'AAA' long-term rating given to the nation and its citizens.

Below are some of the paragraphs in "United States of America Long-Term Rating Lowered To 'AA+' Due To Political Risks, Rising Debt Burden; Outlook Negative", Standard & Poor’s Downgrade Opinion. Without listing those paragraphs, the writer won't be able to explain the complicated aspect of the Downgrade. The writer highlights the parts which the writer believes that they are related to the political risks which Standard & Poor’s assessed. The writer's responses or comments are in blue color.

" We view the act's measures as a step toward fiscal consolidation. However, this is within the framework of a legislative mechanism that leaves open the details of what is finally agreed to until the end of 2011, and Congress and the Administration could modify any agreement in the future. Even assuming that at least $2.1 trillion of the spending reductions the act envisages are implemented, we maintain our view that the U.S. net general government debt burden (all levels of government combined, excluding liquid financial assets) will likely continue to grow. Under our revised base case fiscal scenario--which we consider to be consistent with a 'AA+' long-term rating and a negative outlook--we now project that net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021. Even the projected 2015 ratio of sovereign indebtedness is high in relation to those of peer credits and, as noted, would continue to rise under the act's revised policy settings." Standard & Poor’s Downgrade Opinion paragraph 12.

In paragraph 12, the writer sees Standard & Poor’s has no faith in both Congress and the Administration and the writer believes Standard & Poor’s thinks for the worst.

" Our revised upside scenario--which, other things being equal, we view as consistent with the outlook on the 'AA+' long-term rating being revised to stable--retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, we project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 77% in 2015 and to 78% by 2021." Standard & Poor’s Downgrade Opinion paragraph 14.

" Our revised downside scenario--which, other things being equal, we view as being consistent with a possible further downgrade to a 'AA' long-term rating--features less-favorable macroeconomic assumptions, as outlined below and also assumes that the second round of spending cuts (at least $1.2 trillion) that the act calls for does not occur. This scenario also assumes somewhat higher nominal interest rates for U.S. Treasuries. We still believe that the role of the U.S. dollar as the key reserve currency confers a government funding advantage, one that could change only slowly over time, and that Fed policy might lean toward continued loose monetary policy at a time of fiscal tightening. Nonetheless, it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021." Standard & Poor’s Downgrade Opinion paragraph 15.

" Our revised scenarios also take into account the significant negative revisions to historical GDP data that the Bureau of Economic Analysis announced on July 29. From our perspective, the effect of these revisions underscores two related points when evaluating the likely debt trajectory of the U.S. government. First, the revisions show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher. Second, the revised data highlight the sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions. We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand. As a result, our downside case scenario assumes relatively modest real trend GDP growth of 2.5% and inflation of near 1.5% annually going forward." Standard & Poor’s Downgrade Opinion paragraph 16.

" When comparing the U.S. to sovereigns with 'AAA' long-term ratings that we view as relevant peers--Canada, France, Germany, and the U.K.--we also observe, based on our base case scenarios for each, that the trajectory of the U.S.'s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015." Standard & Poor’s Downgrade Opinion paragraph 17.

The key element of Standard & Poor’s revised upside scenario assumes that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, Standard & Poor’s views this scenario as consistent with the outlook on the 'AA+' long-term rating being revised to stable as states in paragraph 14. Among other factors, Standard & Poor’s revised downside scenario assumes that the second round of spending that the act calls for does not occur, and Standard & Poor’s views this scenario as being consistent with a possible further downgrade to a 'AA' long-term rating as states in paragraph 15.

In paragraph 12, Standard & Poor’s actually uses the revised base case fiscal scenario projects that net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021. It is confirmed that Standard & Poor’s uses this scenario as states in paragraph 17.

In paragraph 17, it states that Standard & Poor’s has not changed U.K.'s 'AAA' long-term rating. Standard & Poor’s main argument is that Standard & Poor’s projects that the net public debt to GDP of U.K. with 80 % debt burden will begin to decline, either before or by 2015. However, it means that 80% debt burden can be acceptable for 'AAA' long-term rating.

According to the revised base case fiscal scenario, U.S. debt burden at 79% in 2015, and it will still be better than U.K.'s 80% debt burden in 2011, which has 'AAA' long-term rating. Based on the U.K.'s acceptable 80% debt burden for 'AAA' long-term ratings, the writer believes that U.S. should be able to maintain 'AAA' long-term ratings until 2015.

The writer looks at those figures from a different angle. U.S. in 2015 is equivalent to U.K. in 2011. In other words, if U.S. in 2011 is shifted four years in timeline, U.S.'s condition will be equivalent to U.K in 2011. The Downgrade, if happens, will be in 2015, not 2011. It means the time period for assessment should be from 2015 to 2019. Based on Standard & Poor’s main argument, if U.S. debt burden will begin to decline, either before or by 2019, U.S. should be able to maintain the 'AAA' long-term rating in 2015.

Let's make an example. Country A has the same economic conditions as U.S. Yet, Country A has a net general government debt to GDP ratios at 1% in 2011, 2% in 2012, 3% in 2013, 4% in 2014, 5% in 2015, 6% in 2016, 7% in 2017, 8% in 2018, 9% in 2019 and 10% in 2020. Country A's debt burden growth is 1% a year until 2020. After 2020, Country A's data is not conclusive. With so many variables, it is difficult to project data after 10 years. Based on Standard & Poor’s main argument, Country A won't be able to keep the 'AAA' long-term rating because the debt burden will still inclines in 2015. However, it may take some seventy years for Country A to reach a level of debt burden comparable to U.K. in 2011.

Isn't it a bid too early to downgrade Country A in 2011? The writer believes that Standard & Poor’s U.S. Downgrade in 2011 was based on an incorrect conclusion.

" The act calls for as much as $2.4 trillion of reductions in expenditure growth over the 10 years through 2021. These cuts will be implemented in two steps: the $917 billion agreed to initially, followed by an additional $1.5 trillion that the newly formed Congressional Joint Select Committee on Deficit Reduction is supposed to recommend by November 2011. The act contains no measures to raise taxes or otherwise enhance revenues, though the committee could recommend them." Standard & Poor’s Downgrade Opinion paragraph 9.

The writer believes Standard & Poor’s loses faith in Congressional Joint Select Committee before they have been even formed. Why didn't Standard & Poor’s give the Congressional Joint Select Committee a chance before downgrading U.S. rating? Why the rush?

" Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act. Key macroeconomic assumptions in the base case scenario include trend real GDP growth of 3% and consumer price inflation near 2% annually over the decade." Standard & Poor’s Downgrade Opinion paragraph 13.

What if 2001 and 2003 tax cuts do expire by the end of 2012? Is there any proof that it will remain in place other than a belief? In paragraph 9, Standard & Poor’s own statement states that the Committee can recommend it.

The writer believes that this assumption hits Republicans a little bit more than the Democrats, and the 2001 and 2003 tax cuts will be under tight scrutiny.

"We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade." Standard & Poor’s Downgrade Opinion paragraph 3.

The writer remembered that the law professor in college compared making law to making sausage. The process of making law was not designed for speedy passage. The writer believes that it is the idea that no law is better than bad law. Nowadays, almost every act, statement and reaction of politicians will show on TV. It may look more contentious and fitful than it really is. If it was a closed door debate, people wouldn't know. In business world, people look at the result. Regardless if it was contentious or fitful, the bill of raising of the statutory debt ceiling did pass within the deadline (Treasury Secretary's statement of the default date). They set the deadline and it was passed before the deadline expired. The writer didn't see the "prolonged controversy" as a base with regards to the less likely of raising revenue in future.

Isn't it a bid too presumptuous for the early U.S. Downgrade? The writer sees Standard & Poor’s view but the writer didn't see the proof.

" Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty, consistent with our criteria (see "Sovereign Government Rating Methodology and Assumptions," June 30, 2011, especially Paragraphs 36-41). Nevertheless, we view the U.S. federal government's other economic, external, and monetary credit attributes, which form the basis for the sovereign rating, as broadly unchanged." Standard & Poor’s Downgrade Opinion paragraph 4.

The writer believes that Standard & Poor’s perception is due to Standard & Poor’s lack of faith in the political process, and the writer believes it is just another subjective opinion.

" The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability." Standard & Poor’s Downgrade Opinion paragraph 6.

The writer is not sure if the Standard & Poor’s said party members actually admitted that he or she used the threat of default as political bargaining chips. One can argue whatever they use or not use are just political tactics or maneuvers. In fact, the political process that Standard & Poor’s slammed has passed several major bills including the bill for raising the statutory debt ceiling. One can also argue that the raising of the statutory debt ceiling was the main plate and the rest were just side dishes because the debt ceiling was a lot more important than the rest at that particular point of time. If Standard & Poor’s wants to put blame on those party members, why not blame the segment of society that they represent? That segment of society may ask Standard & Poor’s whom they represent. The Select Committee which the writer believes that Standard & Poor’s has no faith in is delegated to tackle the debt issue, and debt issue will be the main plate at that time. Standard & Poor’s didn't even give them a chance to try. Standard & Poor’s states, "In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability." It sounds difficult. Here we are talking about rating, not talking to become super-super power. Who? Independent observers agree about the Standard & Poor’s rating? The writer sees Standard & Poor’s view related to how to fix the problem though. If U.S. is a dictatorial country, the dictator in U.S. can simply rob its people to pay the debt. Yet, it isn't.

The writer believes that Standard & Poor’s assessment of political risks is based on one bill and one bill only. The timing of the Downgrade is consistent with that belief.

Isn't the sample size a little bit thin?

Standard & Poor’s assessment is based on one bill that has passed; therefore, the writer believes that the behaviors of the politicians have to play a role in Standard & Poor’s assessment of political risks. The writer wonders whether it would make a difference if the politicians hugged each others after the bill for raising the statutory debt ceiling had passed. What if the House Majority Leader danced with the House Minor Leader? That had to earn some points. If Standard & Poor’s said so, it might be possible to arrange.

The writer sees all opinions in this paragraph are subjective. The writer sees those opinions may seat well as disguised recommendations but not as the base of "political risks" for the Downgrade. The writer believes Standard & Poor’s assessment of political risks is baseless.

"Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers (see Sovereign Government Rating Methodology and Assumptions," June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in framing a consensus on fiscal policy weakens the government's ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging (ibid). A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population's demographics and other age-related spending drivers closer at hand (see "Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now," June 21, 2011)." Standard & Poor’s Downgrade Opinion paragraph 7.

After the 2012 election, U.S. may or may not have a new Congress and a new Administration. Can Standard & Poor’s apply the assessed political risks in 2011 to the political system in 2012? The writer believes Standard & Poor’s can't. Did anyone die after August 5, 2011? Why didn't Standard & Poor’s downgrade U.S. after the election? Why the rush?

The writer heard many people used the word "dysfunctional" regarding the political process. To criticize the political process dysfunctional is one thing but to prove it is the other. If the political process is dysfunctional, it doesn't explain how it has passed several major bills including the bill for raising the statutory debt ceiling. There are many voices and many interests in the nation, and it is not easy to pass a bill related to the debt issue in this economic condition but it is not impossible.

The writer sees smoke here and smoke there in the Downgrade Opinion but the writer didn't see any fire. The writer believes a person who has no faith in the political process may agree about Standard & Poor’s assessments of the political risks, and a person who has faith in the political process will disagree about them. If the agree or disagree depends on the person's own beliefs or persuasions, they are just opinions, not proofs. You don't knock down a heavy-weight champion by your beliefs. You knock down a heavy-weight champion by your fist. The writer believes that the whole Standard & Poor’s opinion is not material enough to uphold the Downgrade which will raise the nation's borrowing costs by $100 billion a year, according to JPMorgan Chase & Co. estimation. Therefore, the writer believes that it is not a legitimate Downgrade.

If it is an illegitimate Downgrade, what do you make of the Downgrade? Standard & Poor’s is a U.S. company, and it is bound by the supreme law of the land, the Constitution. Unlike the Congress and the Administration, Standard & Poor’s has no representation whatsoever. Standard & Poor’s power is not gained through any political process. The Downgrade was an unsolicited rating initiated by Standard & Poor’s. The writer believes that Standard & Poor’s power is comparable to Federal Reserve, and the writer believes that such power is enable Standard & Poor’s to have a super voice in the political system. The effects of Downgrade and the threat of further downgrade are real. The writer believes they pose undue influence to the legislature. A contract is unenforceable if undue influence is present. Did Standard & Poor’s interfere with the political process and injure the Constitution of United States? If the Constitution can be injured, what will happen to Liberty guaranteed under the Constitution?

Standard & Poor’s U.S. Downgrade response on 8-26-2011

Sources:

United States of America Long-Term Rating Lowered To 'AA+' Due To Political Risks, Rising Debt Burden; Outlook Negative

U.S. Loses AAA Credit Rating as Standard & Poor’s Slams Debt Levels, Political Process.