Congress and President Ignore Warning from S&P, Pass Meaningless Debt Package Anyway

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On 14 July, Standard & Poor’s explicitly warned Washington that passage of meaningless legislation would likely result in a sovereign downgrade.

From a creditworthiness perspective, we believe that failure to formulate a fiscal consolidation plan, even if the president and Congress were to agree to raise the debt ceiling in time to avert a potential default, would be materially less optimal than hypothetical scenario 1. Such a partial solution would essentially put before American voters in the 2012 presidential and congressional election the spending vs. revenue debate. Meanwhile, debt would continue to mount and the results of the election might not, in any event, resolve the issue.

Under this scenario, we might lower the U.S. sovereign rating to ‘AA+/A-1+’ with a negative outlook within three months and potentially as soon as early August.

Agreement on raising the debt ceiling without making any tough budget decisions would not be shocking, in our view, given the number of times Congress has done so in the past.

So Washington was warned and Washington ignored said warning.  The budget package failed to cut the minimum $4 trillion S&P felt was needed to begin getting our fiscal house in order.  Essentially, the Budget Control Act is meaningless.  It makes only $917 billion in cuts (but over the next ten years) and leaves an additional $1.5 trillion in cuts to be determined by an ad hoc bipartisan committee with far too much power.

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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.

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“Super Congress” Destroys Constitutional Government

For me and many other Americans, the most Constitutionally flagrant aspect of the Budget Control Act (BCA) rests in the creation of a “Super Congress.”  Forget the fact that the BCA fails to cut spending while it ignores the basic underlying problem of fiscal insolvency.  The creation of a “Super Congress”  to find the additional $1.5 trillion in cuts isolates most of Congress from the ability to legislate budgetary policy and to set tax rates.  This is a gross violation of the Constitution.

There is much speculation throughout the media that this commission will implement stringent tax increases to pay for future budget shortfalls, foreign wars, and growing entitlements. The Huffington Post reported nearly two weeks ago that “A Super Congress would be less accountable than the system that exists today.”  Some see the “Super Congress” as a monumental win for the elite establishment.

  “The establishment of a “Super Congress” will completely demolish the credibility and the authority of the system of elected representatives. It represents another final nail in the coffin of the American Republic and its replacement with an executive dictatorship run by the political elite.” 

The danger lies in the committee’s structure, which affords it a degree of power unseen in American government.  The 13-member committee will be composed of six members from the House and six members from the Senate to be picked by top Congressional leadership, with the 13th tie-breaking vote belonging to the President.  In addition, the committee holds the authority to fast-track legislation through both chambers of Congress, allowing legislators only an up or down vote.  The implication becomes clear when one understands that any legislation coming from the “Super Congress” is tied directly to subsequent debt-ceiling increases.  Considering recent events and the spending addiction that characterizes Washington, the possibilities of Congress failing to raise the debt ceiling in the future are not worth mentioning.  In short, members of the House and Senate will likely be forced to accept anything coming out the group without the ability to propose amendments.  Congressman Ron Paul highlights the group’s effects on Congressional legitimacy.

“Perhaps the most disturbing aspect of this deal is the “Super Congress” provision. This is nothing more than a way to disenfranchise the majority of Congress by denying them the chance for meaningful participation in the crucial areas of entitlement and tax reform. It cedes power to draft legislation to a special commission, hand-picked by the House and Senate leadership. The legislation produced by this commission will be fast-tracked, and Members will not have the opportunity to offer amendments. Approval of the recommendations of the “Super Congress” is tied to yet another debt ceiling increase. This guarantees that Members will face tremendous pressure to vote for whatever comes out of this commission– even if it includes tax increases. This provision is an excellent way to keep spending decisions out of the reach of members who are not on board with the leadership’s agenda.” 

The BCA highlights an increasingly defined pattern in American government whereby Washington grows in power from its own neglect of prudent governance.  Over recent decades, Washington has gained an unprecedented amount of control over the economy.  Now it uses the financial crisis and subsequent debt crisis – which resulted from misaligned policies originating from Washington – to grant itself unprecedented powers that not only trample Constitutional government, but isolate many of its own members.  This amounts to nothing less than a death spiral of representative government.  I urge you to inform yourself and to stay informed of these matters, for despite the meaningless rhetoric of “our children’s future” emanating from Washington, such legislation effectively strips us from any power to control our own financial destinies.

Below is a video from Fox News.  While I normally stay away from Fox (I feel they are too much part of the mainstream media establishment), this video presents the meat of the issue well.


Raising Debt Ceiling Overlooks Costs, Undermines Future

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Chris Mayer of The Daily Reckoning explains why raising the debt ceiling fails to fix the underlying credit problem in Washington.  His key points:

  • The precise reason why raising the debt ceiling (a common practice in Washington) was so controversial is because the only way for the government to pay its obligations (debt) is for it to take on more debt.

“[R]aising the debt ceiling is not a magic cure-all for America’s debt problems. Raising the ceiling just gives the U.S. Treasury permission to borrow more money. It does that by issuing Treasury bonds and notes — in effect, they take out loans, promising to repay the bondholder the principle plus interest.

Here’s the thing, though — right now, the only way the government can repay its existing debt obligations is to take on more debt!…It’s sort of like using credit cards to pay your mortgage.” 

  • In August alone, the government will need to raise over $650 billion to avoid a shutdown – $500 billion to pay bond holders for matured U.S. Treasuries and another $159 billion to cover the expected monthly deficit.
  • Over the next four years, the government will need to pay bond holders over $3 trillion from additional matured securities.
  • The essential worry in Washington was that failing to raise the debt ceiling would impede the government’s ability to continue “rolling over” its debt (taking out debt to pay for debt).  The implication for the debt-ceiling issue is not cutting government spending in the future, but figuring out how to pay for programs already committed to such as entitlements.
  • A default would surely have resulted in a credit downgrade for the U.S., causing interest rates on U.S. Treasuries to increase.  This worry still persists among investors, so even in the absence of a credit downgrade, major holders of U.S. debt such as China and Japan may demand higher yields on their investment, which means higher borrowing costs for the U.S.

“[A]s more investors worry about America’s financial health, they will need more incentive to buy its notes and bonds. Convincing them to take on the risk will require a higher interest rate.”

  • Higher borrowing costs for the U.S. government will ripple out into the economy, making borrowing costs for everyone increase, impeding lending, job creation, and any chance at a recovery.

“Higher Treasury rates will create a ripple effect, forcing other interest rates up, too. Suddenly, the cost of borrowing money goes higher for everyone, which will encourage more saving than spending.”

The full article can be found here.

Sad But Enlightening Debt Statistics

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To those still hoping to see a reconciliation in Washington over the debt ceiling, the following statistics show that the debt problem is not a Democratic or Republican issue, nor is it an issue that can be solved by raising the debt ceiling.  Indeed, repetitive increases in the U.S. debt threshold have lead to the very problem Washington claims can be fixed by taking on more debt.  The current debt-ceiling debate is nothing more than a political charade meant to mask the vicious death spiral painted below.

The following are 17 national debt statistics which prove that we have sold our children and our grandchildren into perpetual debt slavery….

#1 As of December 28th, the U.S. national debt was $13,877,230,355,933.00.  (Currently, our national debt is 14,342,830,116,551.28, an increase of roughly $500,000,000,000 in just 7 months).

#2 If the federal government began right at this moment to repay the U.S. national debt at a rate of one dollar per second, it would take over 440,000 years to pay off the national debt.

#3 If the federal government began repaying the national debt at a rate of $10 million dollars a day it would take approximately 3,800 years to pay off the national debt.

#4 Today, the U.S. national debt is increasing by roughly 4 billion dollars every single day.

#5 The U.S. government is borrowing approximately 2.63 million more dollars every single minute.

Click to read the rest.

Government spending is quite simply an issue created by government.  Both parties are guilty, and the first and most important obstacle of the American people is to overcome their political allegiances to any given party.  Once this is done, government may be returned to the people.  But the people must first be ready.  That is, we must take account of our own faults so as not to repeat them.  Consequently, we must overcome a second and perhaps more difficult obstacle.  We must come to terms with our own bad spending habits.  Jim Quinn explains the behavioral phenomenon known as the “peacock syndrome” quite exquisitely.

“The herd has been mad since 1970 and with the post economic collapse of 2008, some people are recovering their senses slowly, and one by one. The country was overrun by flocks of ostentatious peacocks displaying their plumage in an effort to impress their friends, families and work colleagues. What set the flaunting American peacocks apart was the fact they financed their splendid display of plumage with $0 down and 0% interest for seven years. The lifestyles of the rich and famous miraculously became available to the poor and middle class through the availability of easy abundant credit provided by the friendly kind hearted Wall Street banks and their heroin dealers at the Federal Reserve.”

This is an intriguing read for those interested in the behavioral implications of economics.

“Sad But Enlightening Debt Statistics” also available on Technorati

 

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