Debt Ceiling and Downgrade

            Through most of the last century, IOU’s from the US national government have been universally regarded as being just as good as its cash.  There was never any question America would pay its bills in the promised amount, at the promised time, no matter what. 

All that changed last week when the rating agency Standard & Poor’s notched us down from AAA to AA+, the first time a rating agency ticked our government’s credit score since 1917.

AAA = “An obligor has EXTREMELY STRONG capacity to meet its financial commitments.”

AA+ = “An obligor has VERY STRONG capacity to meet its financial commitments. It differs from the highest rated obligors only in small degree.” [see here]

            Honestly though, it’s not much of a distinction.  This credit downgrade is the global financial equivalent of your grandmother’s flick on the ears for putting your elbows on the dinner table.  Its S&P’s way of sending a message, a stern warning, even.  

Any effect the downgrade has will be largely symbolic, psychological and/or indirect.  Especially given that the other two ratings agenices of S&P's clout-level, Moody’s and Fitch did not alter their credit evaluations for the US.  S&P acted alone on this one.  This is not really a consensus opinion.    

On the other hand, S&P is an influential trend-setter of sorts.  It’s been around in some iteration since the time of the Civil War, the group is humongous, there’s some real rock-stars who work there…and I mean, heck, if they let you give credit scores to countries, you kinda have to be a big deal.

Their reasoning for the downgrade was 1) they don’t think the resultant debt deal adequately addressed our long-term financial situation.  Really, though, does anybody?  That one was not much of a surprise…

…and 2) the US Federal Gov’t, in S&P’s opinion, has shown itself to potentially be too dysfunctional to manage to pay its debts regularly, even when it has the ability to do so, as was threatened over the last weeks. 

In other words: “Who cares if lenders aren’t getting their money because the US can’t pay or because they won’t pay?  Either way, if they don’t pay, lenders won’t get their money, and that makes us here at S&P a bit skeptical about lending to the US.”

That one was kind of a surprise, but now that I think about it, it’s more surprising that it came to everyone as such a surprise, you know? 

In the end, everyone got paid in full, and on time.  So lucky for all of us, at least for now default is still only a waiting disaster.  All in all, it’s not the worst way the debt ceiling squabble could have ended. 

The securities market is pretty rocky right now.  We're in a period of adjustment, bond holders will have to decide if they still want to hold their US debt claims, interest rates pegged to or set in relation to treasury bonds may have to be tweaked, equity claims containing bonds will have to be reevaluated, and so on.

So expect a fair amount of ups and downs in most financial barometers (those are the Dow-Jones IA, the NASDAQ, the S&P 500 and the like) until the dust settles and the markets re-equilibrate.  They’re likely to just wind up around where they were in the first place after a world wide financial Chinese firedrill.

But an absolute nose dive is not looking likely – at least not at this moment.

That being said…

When I began writing this post, I was thinking it would be about the debt deal and the effects of our credit downgrade.  I got a few paragraphs in though, and decided I was so tired of hearing about it, I didn’t even want to think about it anymore, or write about it.  Besides, between money.cnn.com, online.wsj.com and economist.com, there has been more than enough play-by-play and much more insightful commentary about the whole thing than I’d be able to produce.

            However, there is one detail about the little meltdown Washington just had that I really wish got more coverage over the last month.  So I’m going to take the opportunity here to call it out.  It’s subtle one, but I think you’ll find it pretty meaningful. 

            Here goes:

            The US executes budget plans over fiscal years.  But it passes them on a calendar year schedule.  Effectively, we always are making our budgets one year in advance.  That means that at any given moment the spending the government is doing is spending to realize and execute a budget plan made in the previous year. 

            When the Treasury department ran out of funds the first day of August, the borrowing they wanted to do (borrowing that would “increase the debt ceiling”) was to meet the requirements of last year’s budget plan for August 2011, NOT the budget plan Congress was debating at the time.

            The budget that we finally agreed upon on 8/2/11, wasn't due until 9/30/11 and doesn't go into effect until 10/1/11.  The budget we are presently subject to is one we set last September (well, it was due 9/30/10, the final product was delayed until early 4/11, but that's besides the point).

            Back in June/July, when John Boehner and the House Republicans (cool band name?) first announced they were going to refuse to raise the debt ceiling, it was a refusal to fund spending they and the rest of Congress had approved and demanded already – the spending they (and any other previous Congresses) had scheduled earlier to happen now (“now” being summer 2011).  They would block the raise, they threatened, until the budget plan they had made for 10/11 - 9/12 was accepted. 

            So a handful of Congressmen used their power to block current borrowing (borrowing that Congress had demanded and scheduled months ago to happen now) as a bargaining chip in negotiations over next years budget, ie the budget for the end of 2011 and most of 2012.  I'm not sure a lot of people caught that, and I didn't hear that point get hammered too hard during the whole fiasco.

The 8/1/11 debt ceiling rise had no direct bearing on the budget that was approved 8/2/11 (at best its an indirect, or symbolic connection).  Those who threatened to block the debt ceiling increase were threatening to prevent today’s ability to pay the loans we signed up for last year, to force the rest of Congress to adopt their ideas for how Washington’s finance should look next year.

It’s kind of like refusing to pay your mechanic until your car insurance provider agrees to decrease next year’s premiums.  There’s a connection there, but it’s a fuzzy one.   

I think this is the big reason that the budget debate got so deadlocked so fast.  It started off with a hostage situation.  Boehner and allies often refused to negotiate the version of the 9/11 – 9/12 budget they brought to the table.  By saying they wouldn’t okay the borrowing needed now, they tried to unilaterally force a budget into effect under threat of causing the US to default on some of its obligations.

So the Boehner group told us “these are our demands, if they aren’t met we blow all of us up, and no we won’t negotiate.”  I don’t think it’s much of a surprise that no one in Congress was willing to nod their heads and just go along.  

The deal we’ve ended up with is really just a postponement of this fight.  I expect "THE debt" to become a major talking point come election season, up there with "same sex marriage," and the usual smattering of "immigration reform."

What’s scarier to me is now that Congress has figured out how to play "debt-ceiling chicken," will they try to use it again in different scenarios? 

“Reinstate ‘Don’t ask, don’t tell,’ or we force a default at the next debt ceiling.”  Or “my new immigration policy becomes America’s new immigration policy, or we blow up the bond market.”  We have the legal mechanism - and now the cojones too - to make ultimatums like these the next big thing.  And it wouldn’t take too many little Neros in Congress to pull it off.

The sad part is that Boehner and company frankly had some great ideas, and some of their ideas were definitely worth considering.  But the way they went about it, threatening to cause a financial panic just to get their vision for the future budget enacted was reckless and adolescent.  If he had started his discussion a few months ago, we could have had the time to figure this budgetary plan out right, not cob something together at the 11th hour as we did. 

So maybe S&P wasn’t that far off the mark.  In American, politics is a national sport.  Good drama, TV quality speeches, colorful characters and eternal conflicts.  Unfortunately, the political dysfunction that makes the news so damn entertaining to follow is starting to cause some tangible, real and significant damage.

PS - Many Americans don't feel completely confident in their understanding of how finance and economics actually works, and politicians and pundits take advantage of the confusion constantly.  Check out this slide show from the Washington Post for some recent examples.