As we get the final details of the debt ceiling deal between President Obama and Congress, we still have to wait for the verdict of the credit rating agencies. Will they give us the thumbs up or will they tell Congress that it has to take even more money from the poor, the sick and the elderly before the credit rating agencies reaffirm the top credit rating of the US government?
The media have spent much of the last two weeks telling the public that the judgment of any deal by the big three credit rating agencies, Standard and Poor's, Moody's and Fitch, will be the key to its success. We were told that the smaller deals being discussed between President Obama and the Congressional leadership might not be sufficient to maintain the United States top credit rating. We may have to make bigger cuts to programs like Medicare and Social Security to keep the rating agencies happy.
Before we throw the beneficiaries of these programs to the wolves, we might think a bit more about what the credit rating agencies are. Of course, the credit rating agencies were last seen giving top quality investment grade ratings to mortgage-backed securities that were filled with garbage loans.
These loans were used to buy homes at bubble-inflated prices on terms that the borrower almost certainly could not meet. In many cases, the mortgage agent had deliberately filled in wrong information to allow buyers to get mortgages for which they were not qualified. But this was all fine by the bond rating agencies. And the rating agencies were paid tens of millions of dollars for the investment grade ratings that they delivered
This was not the only time the credit rating agencies got things seriously wrong in the lead-up to the crisis. Lehman had a top investment grade rating right to the very end, as did Bear Stearns. The fact that these huge investment banks held hundreds of billions of dollars of subprime mortgage-backed securities did not bother them.
Nor did it bother the credit rating agencies that AIG had issued hundreds of billions of dollars of insurance - credit default swaps - against subprime mortgage-backed securities. AIG was triple Aaa right until the end.
It wasn't just this crisis that the credit rating agencies got wrong. Enron managed to hide tens of billions of dollars in debt on the books of its subsidiaries. This was improper and illegal, but it fooled the credit rating agencies. WorldCom managed to boost its profits by treating tens of billions of dollars of routine maintenance expenses as capital investments to be depreciated through time.
In short, the credit rating agencies qualify as the Keystone Cops of the financial world. That is assuming, of course, that it is not simply corruption.
But apart from the issue of the competency of the bond rating agencies, there is a more basic question. What would it mean for the United States to default on its debt?
This isn't an economic or philosophical question; it is a simple matter of logic. The United States borrows in dollars. The United States also issues dollars. How could the United States ever be in a situation where it can't get the dollars needed to pay off its debt? Apart from a debt ceiling debate, where Congress effectively forces a default for reasons that have nothing to do with the country's creditworthiness, it is pretty much impossible to see how the country could default.
It could be argued that printing dollars would lead to inflation, which would reduce the value of Treasury bonds. While this may be true, if this is the criterion that the bond rating agencies are using to evaluate debt, then any expectation of increased inflation would necessarily imply a downgrade of all debt issued in dollars. However, none of the credit rating agencies are talking about an across-the-board downgrading of dollar-denominated debt.
Before anyone gets too excited about the risk of a downgrade, they should have an idea of what they think it means. I have yet to see anyone provide a remotely coherent explanation of what the credit rating agencies would be saying if they downgraded US government debt.
There are a lot of Wall Street finance and Washington policy types who desperately want to cut Social Security and Medicare. They are willing to lie, cheat, steal and spend tons of money to accomplish this goal. The threat of credit downgrade is a great piece of ammunition for this gang. We should torture them by insisting that they explain what it means before they can be taken seriously.
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