Sic transit gloria mundi
How doth the busy bee
Dum vivimus vivamus
I stay my enemy!
Last night, I had the most peculiar of nightmares.
I woke up this morning in a cold sweat after having a dream involving rallying around my family with a pocket full of shells. I was holed up in a small bar located in what felt like the Deep South, but looked like it was nestled in the midst of the Mojave Desert.
Armed with an old Winchester rifle, I was organizing the defense of a town from a group of religious fanatics who wanted to kill me.
Coincidence or Prescience?
After being roused from my disturbing dream, I could not fall back to sleep, so I checked my email.
What I found was shocking.
For the first time in history, Standard & Poor’s lowered America’s credit rating from AAA to AA+, and warned that a further downgrade to AA was possible.
The agency argued:
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.”
The agency further maintained:
“The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.”
It turns out that a failure to raise additional revenue, cut entitlement spending, and the general instability of America’s political process drove the downgrade.
In other words, the wing nuts of both parties are putting the country’s financial stability at risk.
While some my argue that this downgrade is largely symbolic, I disagree.
There is a reason S&P announced its decision on a Friday afternoon, after market close.
For the first time in history, U.S. Treasuries are no longer deemed risk free investments.
A lower credit rating implies higher credit yields, because investors will demand a higher return on a riskier asset. As Treasury yields rise, so too will other interest rates ranging from borrowing costs for corporate debt to mortgage rates. Higher interest rates increase borrowing costs, and thereby reduce business investment, and make financing a house less affordable. To sell a home, prices will have to come down further to accommodate higher mortgage rates.
The bottom line is that a downgrade increases the probability that the country will experience a double dip recession.
Furthermore, the U.S. debt rating has been stable for so long, that a change in its status will increase global uncertainty. For instance, in business school, professors teach students to use the 5 or 10-year Treasury rate as the so-called “risk free rate” when valuing companies via the capital asset pricing model (CAPM). Now that U.S. Treasuries are no longer risk free, how does one value an asset without using U.S. Treasuries as the risk free rate? I suppose one should now be using the yield on Canadian, or Australian sovereign debt.
Either way, the glory and prestige of American power is starting to fade.
All Shall Fade
And so passes the glory of America.
Reflections of a Rational Republican 
It’s interesting that you preface this with a quote from Emily Dickinson in the paper founding the Republican Party. I don’t think she’d recognize the Party today.
I don’t think she’d recognize either party.
It’s interesting to me that neither Moody’s nor Fitch decided to lower the US credit rating.
The Machiavellian part of me wonders if S&P simply drew the short straw. Having one of the big three express its displeasure with the way the politicians in Washington are acting would hopefully be a big enough stick to convince address the matter with the gravity that it warrants, without being so worrisome as to impede the very recovery that they’re hoping for.
Then again, Occam’s Razor being what it is, it’s more likely that S&P simply has a different opinion on the future outlook of US sovereign debt.
Sometimes I think I’d be… reassured, in some ways, if there were more vast, ruthless conspiracies out there. Then at least there would be some consistent logic behind the seemingly nonsensical decisions made by people in power.
If the S&P intended to use this downgrade to communicate a warning to US politicians, in chose a tremendously irresponsible way to do so. By issuing a downgrade, the S&P will negatively impact the recovery on which the US sovereign rating so much depends.
Reading the text of their explanation for the downgrade, there is a significant amount of castigation between the lines, of all parties involved.
S&P evidently feels that political brinkmanship and sovereign debt do not mix.
Agreed.
“convince them to address”… I swear, I don’t usually leave words out.
As you’ve noted, President Obama was willing to do a $4 trillion deal, with only about 17% of it revenue increases. That would avoid the downgrade, and get the country back on the right track. To do this, Obama has taken blistering criticism from the left wing of his party, the so-called “frustrati.” I have heard people claim he’s gone to the Republican side, that Hillary would never allow this to happen, and he’s rolling over to the GOP. He’s taking that criticism — hard to accept from the base just before an election year — because I think he realizes we need to do something.
John Boehner and Mitch McConnell need to stare down the tea party the way Obama has stared down the frustrati. They need to go back to Obama and say “let’s get this done.” There’s no time limit — they could do a lot of this in private — there is a back up in place, however bad it may be. It’s time for them both to stop thinking about politics and 2012 and realize that right now the country needs a major turn around. Obama will handle the frustrati. Can Boehner and McConnell handle the tea party?
Looking at the situation in London, I’m wondering how long it will take S&P to hand out a downgrade there…
That’s what happens when people start depending on long-term government support. When you withdraw it, they will sometimes react violently.
No doubt. The question becomes what impact these riots will have on the political process. Historically, they have a tendency to cave into mob demands, which could have unfortunate consequences, particularly in light of S&P’s recent behavior towards the US.
Unfortunately, this is the logical and inevitable progression of the social welfare state.
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