What Does It Mean That the S&P Downgraded the U.S. Credit Outlook to Negative?

Photo: Casey Fleser / somegeekintn.com/? Casey Fleser

Yesterday, for the first time since Pearl Harbor, Standard & Poor's lowered its confidence in America's ability to pay back its debt. According to the S&P's magic 8-ball, the budget impasse between Republicans and Democrats was likely to keep the U.S. from addressing its budget deficits and mounting debt. The downgrade from "stable" to "negative" wreaked havoc on the stock market and sent politicians scrambling to use the news to advance their agendas. But is a "negative" outlook really as bad as it sounds?

The Atlantic's Clive Crook thought there should be scare quotes around the S&P's "bombshell":

"S&P adduces no new information that I can see. Competent ratings of opaque instruments such as, oh, mortgage-backed securities would be very useful to investors (not that ratings agencies troubled to provide competent ratings in that case, obviously). But why should anybody need that kind of help in judging the soundness of US government bonds? S&P knows nothing about them that you or I don't know.

This Can't Be Happening's Dave Lindorff wondered if the S&P just wanted to run "interference" for the GOP's efforts to "crush social security and Medicare."

At least one economist burst out laughing on hearing about the S&P announcement. "They did what?" exclaimed James Galbraith, a professor of economics at the University of Texas in Austin, who formerly served as executive director of the Congressional Joint Economic Committee. "This is remarkable! It certainly will confirm the suspicions of those who have questioned S&P's competence after its performance on the mortgage debacle."

Since the US prints its own currency (or actually just issues electronic payments to create new money) whenever it needs it, as Galbraith puts it, “As long as there is diesel fuel to power up the back-up generators that run the government’s computers, they will have the money to back their own bonds.”

Although major U.S. creditors like Japan, South Korea, and India seem unperturbed, China has yet to weigh in:

With inflation at a three-year high in China and some economists speculating that the U.S. assets may be a cause, the news certainly rang some alarm bells in Beijing. Should China decide to shed bonds, American markets could take another blow.

The Washington Post's Ezra Klein says "S&P got seriously scooped" on the news that Congress was paralyzed with gridlock.

The rating agency’s concerns were treated with somewhat more urgency in Washington, where politicians of both parties rushed to the cameras to warn that the only way to keep S&P from downgrading our credit at some future date would be for the other party to stop standing in the way of their policy preferences ... But that’s par for the course with Congress, which seems to be doing everything in its power to undercut the market’s opinion of America.

Bradford DeLong pointed out that the dollar actually strengthened after the announcement and reclassified the downgrade as a piece of "political news"

My guess — which might well be wrong — is that we saw the price pattern we saw because Ms Market views the S&P announcement as a political move. Congress, she may be thinking, is like a mule: it only moves when hit with a whip. Normally the whip to get a deficit-reduction deal is fear of the bond market's producing a spike in interest rates and borrowing costs, but perhaps a fear of a ratings downgrade will do instead. And my guess — which might well be wrong — is that the dominant view of Ms Market is that this will harm equity holders not so much by loading more of the burden of balancing the budget on corporate and capital gains taxes but, rather, by slowing recovery and raising the risk of a double dip.

Over the next few months we will see if Ms Market is right.

Related: S&P on U.S. Credit Outlook: Prognosis Negative