Was S&P's downgrade of the U.S. unnecessary?

Aug 08, 2011

Standard and Poor's downgraded the U.S. government's credit rating, leading to a heated debate about who's to blame on Capitol Hill, a sharp decrease in the stock market, and potentially harmful impacts on the world-wide economy.

But was this downgrade necessary? Former secretary of labor in the Clinton Administration Robert Reich doesn't think so.

Chat with Reich Monday at 1 p.m. EST about why he thinks S&P made a mistake, and why this second recession could have been avoided.

Ask questions and submit your opinions now!

Slouching toward a double dip, for no good reason

Hi. I'm here, ready to chat. Looking forward to your questions. 

Is my 403b retirement plan stock going to come back in a few months?

If I knew that I'd be a rich man. 

Why not now? Does it make sense to recognize the problem now rather than later?

Credit rating agencies are supposed to advise investors as to safety of a security -- whether they're likely to be repaid. Credit rating agencies have no authority -- or reason -- to get involved in deciding by how much or how or when a nation's debt should be reduced. S&P went way beyond bounds. 

I am sure someone else is asking this, but here goes anyway - I get why they lowered the rating, but given their role in the mortgage crisis where they continually rated subprime mortgages very favorably, why should anyone [care] what they think?

Unfortunately, many worldwide creditors do pay attention. Some are required by law to do so. But you're right -- given S&P's poor track record, there aren't many rational grounds for paying a lot of attention. 

How can the press still make the deficit deal a 50/50 disaster? Clearly the Tea Bag People won the day and a phony crisis became a real downgrade.

Yes -- the only real threat that the US won't pay its creditors in the future is the possibility that tea-party Republicans will do at the end of 2012 what they did recently, and hold such payment (that is, an increase in the debt ceiling) hostage to their political demands. Had S&P based its downgrade on this danger, at least S&P would have had some understandable and legitimate rationale. 

Assuming neither President Obama nor the Democrats successfully push for any true economic stimulus, which I wouldn't think is much of an assumption, is there any way we can get the economy growing and creating jobs or will we just have to wait out this disaster?

The Fed has proven that almost-zero interest rates, even coupled with "quantitative easing," has little effect. I think that's because both are analogous to pushing on a wet noodle. Big corporations already have all the capital they need, as does Wall Street, and wealthy individuals. Smaller businesses and average people can't get capital because banks are reluctant to lend. So monetary policy won't and can't work. What's left? Fiscal policy. President Obama and the Democrats have to go to the nation with the truth -- that we need a large fiscal boost this year and next. 

How can Americans be assured that the additional tax dollars will be used for the benefit of our future?

No one is talking about additional tax dollars. We're talking about boosting the economy through additional spending and tax cuts on the middle class -- which will generate faster growth and thereby reduce the ratio of debt to GDP. 

Prior to the Standards and Poors downgrading of Federal government bonds, a ratings agency in China had downgraded these bonds. What did this downgrading in China mean and what affect did it have?

China is sending us a signal. It doesn't want the dollar to drop and for its huge holdings of US dollars to decline in value. It would much rather we fixed our long-term debt problem. It also doesn't want to be blamed for the current mess we're in. 

The Financial Times agreed that this was a mistake, particularly the timing. However S&P's actions were consistent with their statements. Isn't the heart of this issue good governance in the U.S.?

No. The heart of the issue right now is lack of sufficient aggregate demand -- consumers, businesses, government -- to get the economy going. And if consumers can't and businesses won't (they won't without consumers), the near-term responsibility shifts to government. Our "bad governance" is an inability or unwillingness to stimulate the economy as much as it needs. 

As former Secretary of Labor, you'd know how the interface between gov and businesses work. What are the keys to a successful program? Sports analogies would be great.

Obviously I don't know what he will say. What he should say is: We don't have a debt crisis right now. We have a jobs, wages, and growth crisis. And I'm going to ask Congress to approve my jobs plan as soon as possible. If they don't, I'm going to fight for it every single day between now and Election Day. My jobs plan will include exempting the first $20K of income from payroll taxes for two years, amending the bankruptcy laws to allow distressed homeowners to declare bankruptcy on their primary residence, creating a new WPA and Civilian Conservation Corps, enlarging the Earned Income Tax Credit, providing partial unemployment benefits for people who have lost part-time jobs, creating an infrastructure bank and using today's low interest rates to hire Americans to rebuild our roads and bridges and airports and transit systems, and providing tax breaks to businesses that create net new jobs. If we restore jobs and growth, we'll reduce the long-term ratio of debt to GDP. 

Isn't it true that it would better stimulate the economy if we put more money into the hands of middle class and lower class consumers, as they tend to blow it all on food, shelter, clothing, etc., than to put it in the hands of higher class consumers who tend to save it and put it into investments that have slower multiplier effects?

Yes. Indeed, the fact that the top 1 percent now gets a larger share of total income than at any time since the late 1920s, has contributed to the mess we're in -- because it's reduced the purchasing power of the vast middle class. The rich save more than does the middle class, and what we need now isn't more saving; it's more spending and investing -- public and private. 

Recently you noted how dependent ratings companies were on the banks, etc which issue the debt they rate. Is there another model which would work for rating securities? A model which removes this conflict of interest & is politically workable.

Yes. Credit-rating agencies should be paid by those who use them, not those who issue the securities they're supposed to be rating. The best proxy for users are institutional investors.

There are reports that China is now permitting the revaluation of the Yuan against the Dollar. How will this (likely) affect prices at WalMart and the Dollar's standing as the world standard currency?

Prices at Wal-Mart and elsewhere in the US economy will rise to the extent we can no longer rely as much as before on cheap (and subsidized) goods from China. Those price increases may feed inflation. But I suspect before that happens, Wal-Mart and other large buyers in the US will figure out how to do more in Vietnam, Cambodia, Indonesia and other places where very cheap labor is still priced cheaply. 

How do you think the recent history of the economic recovery might have unfolded differently if Democrats had retained a majority in the House in the 2010 mid-term elections?

We wouldn't have been subjected to the hostage crisis created by tea-party Republicans. And it's more likely Obama and Democrats could have enacted a second stimulus whose size was commensurate with the actual shortfall in aggregate demand. 

That the downgrade was unecessary is a given. The question is what should the response be to S&P. this is a group that is leveated to NSRO staatus as one of three private comapnies who analyze the credit worthiness of debt instruments. There track record with motgage junk bonds rated as AAA right up to the crisis and their now error filled analysis of the downgrade, why can't or shouldn't the President put S&P's NRSO status on probation and have them prove why they should still be trusted. Given that the Treasuries have not suffered based on the "downgrade" why shoud we pay attention to S&P at all ever again?

I don't think the downgrade was necessary at all. (See my previous answer.) S&P is neither standard nor poor. It's aberrant, and the real onus of its decision will disproportionately affect the middle class and the poor. 

You and others have made a persuasive case for pursuing a jobs plan and leaving the debt theatre behind. At the present moment, it appears our nation's decision makers are not making decisions like the ones you've laid out in your previous answer (easing income tax on the first $20k, etc.) What would be the argument against your approach, and/or why haven't our nation's leaders adopted your approach? Also, has President Obama solicited your advice?

I can't give you the argument against my approach because I don't understand it. It's based on classical (now neo-classical) assumptions about the economy that are so removed from reality they barely merit attention. It's as if Herbert Hoover's Secretary of the Treasury, Andrew Melon, had been exhumed. Our nation's leaders are either deluded into thinking the neo-Melons are correct, or ideologically driven by a desire for a smaller government (which has nothing whatever to do with the current jobs and wage crisis), or -- in many cases -- intimidated by an increasingly loud right-wing chorus that blames everything on government, and always has. 

With the US downgrade, what is the risk of German, French, et al. downgrades? If this happens, does the ECB have the wherewithal to stem contagion in the Eurozone?

Europe's debt crisis has nothing to do with the faux "debt crisis" in America. There, Italy, Portugal, Ireland, Spain, and Greece may not be able to pay their debts. But the U.S. has no trouble at all paying its debts -- so long as tea-party Republicans don't stop it from doing so. We're the richest nation in the world, and we print the money most of the world relies on. The US downgrade by S&P is so bizarre and unwarranted -- while much of Europe is in such serious jeopardy -- that S&P's actions here don't have much bearing there. 

While I think you can easily question what S&P has done, I have to add that I've always heard that the reason that government bonds have such good ratings is that since the government has the power to tax, there will always be an appropriate amount of revenue to support debt. I guess, though, that is only if the goverment is willing to tax.

Tax or print money, or both. But, again, let's be clear. The US government should be able to run very large ratios of debt/GDP for quite some time before it's necessary either to tax or print more money. The current debt/GDP ratio is about 71 percent (when I last looked). That's high, but manageable. And the sooner we restore growth -- the denominator of that equation -- the more manageable it will be. 

Rather than focusing on S&P's past when evaluating its current credibility, what about pointing out that its two competitors have not downgraded the US credit rating? How significant to the market is it that the S&P is on its own?

You're right, and my sense is Moody's and Fitch both understand their job -- to assess the safety and soundness of loans to the U.S. -- rather than to venture into U.S. politics, as S&P has done. 

Why are the standards (such as they are) so different between these agencies even on sovereign debt? Why did S&P alone have so much impact?

We don't know yet the full impact of the S&P decision. But remember, we're dealing with individuals. S&P's sovereign debt committee is headed by John Chambers, who, along with several colleagues, have been very concerned about trends in the U.S. debt. Frankly, I think they lost sight of their real job. Maybe, after having blown it so badly before the debacle on Wall Street, they decided to become overly aggressive. Or perhaps they're doing the bidding of some of the big Wall Street banks. I simply don't know. 

When two people dine at a restaurant and one of them says that it was the best meal he has ever have, and the other one says it is the worst meal he has ever have - both of them could be right. However, US credit rating is not equivalent to a restaurant review, or is it? Why such divergence of views? Do those who minimize the importance/potential dangers of downgrading have a point, or those who take the downgrading seriously have a point?

Downgrading is serious. If either Fitch or Moody's joins in (and I doubt they will -- but it's possible), the negative effect will be multiplied. US credit ratings should not be like move or restaurant reviews. They should be serious attempts to assess the likelihood that a given loan will be repaid. In the case of the United States, as I've stated, the only chance we may default at some point in the future is if we go through a repeat of the fiasco the tea partiers just put us through. Anything else -- including S&P's avowed worries about how big our debt may be, by how much it should be reduced over the next ten years, how it should be reduced, and the difficulties of doing so given our politics -- is irrelevant. 

No, I don't think the downgrade was necessary at this time. Why did they wait until after the increase of the debt ceiling rather than before to do this? It appears that politics played a role and since they missed projecting the financial meltdown in '07, they're trying to make it up on the backs of average Americans!

Exactly. If S&P thought it was authorized to enter the political fray, why didn't it speak up when George W. Bush cut taxes, began two foreign wars, and created his giant Medicare drug benefit? 

How could this recession have been avoided?

We now know the economy shrank much more between the end of 2007 and the start of 2009 than was thought at the time, so we needed a much larger stimulus (including fewer tax cuts, which were just used to bolster saving). Some of us argued at the time for $1.2 trillion in added spending. With the benefit of hindsight, even this was too little. States and localities have cut so much they've just about negated any boost from the federal stimulus. 

In regards to a 'second recession' , is there perhaps a chance that this ongoing fiscal crisis will take years to run its course just like during the depression years. That perhaps there was nothing to be done then either, only ' time' was the answer for the balance sheets of the average consumer to right themselves?

I don't buy this "we can't do anything" view. Yes, it will take time to "work down" consumer debt. But history has shown us that fiscal policy, properly directed, and work. It worked (albeit in a haphazard way -- FDR didn't really know what he was doing) in 1934, 1935, and 1936. But then it was reversed, and the nation plunged into another deep recession in 1937. It appeared to work to help mitigate the effects of post-war recessions -- so well that Richard Nixon was famously purported to declare "we're all Keynesians now" (he didn't say it exactly that way). What gave Keynesianism a bad name was the stagflation of the 1970s, and the nation's justifiable fear of inflation in the following decades. But look closely and the real problem in the 1970s had more to do with skyrocketing oil and food prices (the Arab oil embargo); and the strong recovery of the 1980s a lot to do with Reagan's military Keynesianism (cutting taxes while boosting defense spending). The real irony today is that Keynes is more relevant and important than at any time since the Depression, but his detractors have gained so much traction over the last three decades that it's hard to make the case. 

Why can we just go with a flat tax, instead of the tier system we have? That way everyone could pay their fair share. No deductions so the wealthy couldn't pay tax advisors to find loopholes to help them avoid paying what they should for what they make.

"Fairness" is in the eye of the beholder. But it does seem to me that one of our underlying problems is that such a large share of the nation's income is now going to the very top (who save far more of their income than others) that aggregate demand isn't what it would be, had our nation's productivity gains been more widely shared. So on grounds both of fairness and growth I'd opt for more and higher brackets at the top. 

Will there be a movement by the Europeans and Americans to create a new international ratings agency so they have an alternative to the private sector ones (i.e., something along the lines of the IMF, World Bank, etc.)

Not a bad idea, although steps would have to be taken to assure that the ratings agency was shielded from politics. 

Enron and Lehman weren't downgraded until the weekend before they filed bankruptcy. Why shouldn't we believe this action is long overdue?

Enron and Lehman were in imminent danger of going down the tubes and not being able to pay their creditors. The United States is in no such danger economically. The only danger we won't pay our creditors is if tea-party Republicans pull another hostage crisis. 

Robert, how long do you think it will take before the U.S. regains the AAA rating from S&P and what do you believe the federal government must start doing, now, towards that goal?

To be perfectly candid, I think S&P has completely blown its credibility and I wouldn't worry about regaining a triple A rating from it -- for all the reasons I've stated before in this forum. 

Do you think we're heading into another recession, or are we in a long-term process of contraction, driven by consumer de-leveraging?

I'd give the possibility of a double dip to be 50-50 right now. I don't buy the idea of a "new normal" of high unemployment and slow growth. That's not necessary -- and it's not sustainable socially or politically. 

Much has been said that we are in a financial crisis and not a classical business cycle correction.What is your opinion and what are the remedies,increase acceptable inflation rate, currency devaluation, infrastrcture bank?

The Fed may need to induce a bit more inflation in order to avoid deflation, but inflation isn't a way out of the mess we're in. Nor is a declining dollar -- which will only prompt competitive devaluations. The answer is a bunch of things I've mentioned before (exempting first $20K of income from payroll taxes for two years, recreating WPA and CCC, creating a large infrastructure bank capable of taking advantage of low Treasury rates and investing in roads, bridges, ports, airports, and public transit, loans from the fed to cash-starved states and locales, partial unemployment insurance for the millions of Americans who have lost part-time jobs, and so on). Most of these will require more federal spending in the near term. We have more than enough economic capacity to do all this -- which is precisely the point. The problem is political will. Republicans won't, and Democrats are scared to even bring it up. I haven't checked on what the President said at 1:30 pm, but I doubt he's willing to take the lead on this, sadly. 

How would you advise the average American to weather these storms? The DJIA is under 11,000 as I type. People can't sell homes tp upgrade or move, limiting their ability to relocate for better jobs or pump money into the economy. Many would like to spend but cannot. What would you tell the average American to help them through these times?

If people have savings, I'd tell them not to panic. This isn't the time to liquidate stock holdings or put money under the mattress. If they have homes that losing value, I'd tell them to try to hold on to them. If they're worried about losing their job or declining wages, I'd advise them to try to reduce discretionary spending. All these are, I believe, rational responses by individuals and families. The problem is, what's rational for them is not necessarily good for the country as a whole. That's why we need bold steps by the federal government. 

To what extent can the S&P downgrade be a "self-fulfilling prophecy?"

Could be. We don't know enough yet. 

Um, when did we enter this double dip recession? Last I knew the economy grew 1.3% in the previous quarter.

We haven't entered one, and hopefully we won't. As you probably know, the economy barely grew at all in the first quarter, and the portion of working-age Americans in the work force is lower than its been in almost 30 years. These aren't encouraging signs -- but a double dip can still be avoided. 

Is the down-grade warranted? Was it political?

Completely unwarranted. I can't say about motive.

I agree it was unnecessary, but what do you think was the impetus behind their decision? Are they trying to polish their tarnished reputation? Were they taking advantage of the situation in Washington?

I've put forward several hypotheses during the course of this forum,but have no definite idea or proof. 

What are the possible repercussions for S&P?

Their staggering irresponsibility does little credit to the firm or to their trustworthiness in the future. 

Does the fact that yields on US treasuries keep going down contradict S&P's downgrade? The market seems to be thumbing its nose at S&P right now.

Yes, and well the market should. 

Hello! Have enjoyed your commentary and books for almost 30 years and actually wooed my wife by discussing the Work of Nations. Anyway, here's my question: so long as we have a Congress that is unwilling to raise taxes (and even willing to listen to crazies who would risk default) to ensure that the Treasury services the federal debt, isn't S&P correct to say that the Federal Government that is a riskier borrower than before - justifying the downgrade? (Never mind that S&P bet wrong on Lehman Bros etc....) Thanks!

The federal government is no riskier now than in the past, given that the U.S. continues to be the richest nation in the world and continues to print money the rest of the world relies on. The one danger -- which S&P did not rest its decision on -- is that right-wing Republicans might try again, at the end of 2012, what they tried before, and perhaps they may succeed in preventing the debt limit from being raised. What you or I or John Chambers (of S&P) thinks about when and how and by how much to reduce the long-term budget deficit relative to the size of the national economy is simply irrelevant. By the way, I'm so glad to hear the Work of Nations had at least one practical positive effect on the world. 

Good afternoon Dr. Reich. The debt ceiling debate indicated that political leaders have lost all sense of pragmatism in dealing with the problem. We seem to be a country stuck on ideology now. What do you think it will take for the U.S. to regain pragmatism in solving economic woes? Further economic collapse?

Too many commentators, including the mainstream media, are ready to blame "both sides," as if the truth were halfway between right and wrong. The real threat to sane public discourse, in my view, is a deeply ideological right that's bent on shrinking government no matter what the cost. 

The downgrade was utterly warranted, its attempted justification sloppy. Do you see grounds for a criminal investigation?

No. It wasn't criminal. It was just immensely stupid. 

Really, what's the difference between 94% of GDP (and growing) and 85% of GDP (and growing)? Our political process makes a long term solution virtually impossible. That is a fact, right? Our debt is still going, that is also a fact, right? Even if we pay bonds/interest, to not pay something like Social Security is a selective default. What S&P did was to call out the facts and react upon it. While 2 trillion is a big number, it's not particularly material to the decision made.

There are two separate issues here. The first is by what authority S&P or any credit rating agency acts -- that is, what it's job really is. S&P is not and should not be in the business of telling the US how much, how, and by when it needs to reduce its debt (or its debt/GDP ratio, more accurately). Its job is to alert lenders to the chances of a default, which are as low now as they've ever been -- except for the possibility of another move by tea party Republicans to stop an increase in the debt ceiling. The second -- and entirely different -- issue is how and when our political branches bring down the debt/GDP ratio over the next ten years or so. I have ideas as I'm sure you do, and I'm as concerned about gridlock in Washington as anyone. But I also worry that the current obsession and ideological warfare about the long-term deficit and debt is a colossal distraction from the immediate (and in my view, far more important) goal of rebooting the economy, and overcoming the shortfall in aggregate demand.

Dr. Reich - I'm a big fan of your positions during the Clinton admin and know that you did not get to do all you would have liked. What advice would you give the current admin and congress to help right the ship and build the economy for the future?

I'd push vigorously for a jobs and growth plan (I've outlined what that might be earlier in this forum). I'd advise the President to fight for it, and make it the centerpiece of his 2012 campaign. I'd challenge Republicans to lay out the logic of their bizarre argument that shrinking government will generate jobs and more growth. In other words, I'd shift the public debate away from the (important although distracting right now) issue of the nation's long-term debt, toward the real crisis of jobs, wages, and growth. 

I'm afraid I can't get to the remaining questions in this forum because I have to go, but thanks for your very thoughtful queries. And best wishes to all.

We will survive this storm, as we've survived every other. 

Robert Reich


In This Chat
Robert Reich
Robert Reich is Chancellor's Professor of Public Policy at the University of California at Berkeley. He has served in three national administrations, most recently as secretary of labor under President Bill Clinton. He has written thirteen books, including The Work of Nations, Locked in the Cabinet, Supercapitalism, and his most recent book, Aftershock. His "Marketplace" commentaries can be found on publicradio.com and iTunes.
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