S&P Downgrades U.S. Credit Rating to AA+ Amidst Shambled Debt Deal

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Today’s market news can be summed up in one announcement.  Standard and Poor’s downgraded the U.S. credit rating.  The U.S. has lost its perfect credit score for the first time in over a century.  In response to the butchered debt deal signed into law on August 2, S&P issued a credit downgrade for the U.S. from AAA to AA+. The following are only key excerpts from the press release, the full text of which can be found here. S&P Downgrade of US Credit Rating (5 Aug.)

My contention is that the S&P downgrade is illustrative of the diminishing stability of the U.S. legislative process.  Consequently,  I have included key excerpts that highlight the degradation of the political establishment and its inability to legislate substantive policy due to an increasing divide between Parties.  While there is much more to discuss in the press release regarding the fiscal issues at hand, I find it critical to highlight the inability of the political establishment to perform its most basic functions.

Overview

We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.

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 debt deal, officially known as the Budget Control Act, only cuts $917 billion over the next ten years with cuts yet to be determined of up to $1.5 trillion.  S&P feels that cuts of $4 trillion are needed to start with in order to “stabilize the government’s medium-term debt dynamics”  In other words, the U.S. needs to reduce spending by at least $4 trillion now in order to keep its books from bursting into flames.

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. 

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.

The short interpretation is that markets are beginning to feel the heavy hand of a highly dysfunctional U.S. government, prevalent in both its policies and its partisan bickering.  The differences between the Republican and Democratic parties are so great as to cast a shadow over the viability of an economic recovery and the solvency of the U.S. government.

Rationale

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.

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.

The fact that our political establishment is becoming increasingly unstable – opposing parties residing at opposite ends of a lengthening political and ideological spectrum – sends signals that any policy reconciliations over government spending and programs such as entitlements (Social Security, Medicare, Medicaid) are not likely.  Moreover, the fact that Party politics resulted in using the threat of a default as a “bargaining chip” attests to the instability and recklessness of the American political establishment. Consequently, the hope of the U.S. government reaching a meaningful and lasting consensus of spending reduction is greatly diminished.

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… 

The political grandstanding and chicanery that has come to define Washington politics over recent decades damages confidence within the markets that any mutual agreement on reducing spending will be reached.

The Outlook

We view the act’s [Budget Control Act] 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.

The structure of the Budget Control Act renders any solution to government insolvency largely to be determined.  The act does very little.  This reflects the typical legislative process in controversial matters, whereby the government passes legislation that seems to do a lot, just not right now.  The fact that some of the cuts occur over the next ten years, with the remainder yet to be determined suggests that political division has rendered substantive policy implementation untenable.  In short, our government is fragmented and has become legislatively inept, thus incapable of reaching consensus on important policy matters.

Related Posts:

• “Super Congress” Destroys Constitutional Government
• CATO Video on Short-Comings of Debt Deal
• Raising Debt Ceiling Overlooks Costs, Undermines Future
• What is it About Economics…The Debt Deal Examined
• Sad But Enlightening Debt Statistics
• The Debt Ceiling, A Political Red Herring

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