Well before the totally "Made in Congress" U.S. debt ceiling crisis dominated the headlines, anyone paying attention knows that Europe's long-running debt crisis furiously boils away and the U.S. economy teeters on the brink of a double-dip recession. This has been going on for weeks, if not months. So why did the world stock markets just discover how bad it could be? The Dow is down 635 points today, and almost 2,000 points in the last two weeks. I have a pet theory.
People hoard cash, or things equivalent to cash, not because they want a return, but because they simply don't want to lose. Put another way, people accept little or no return in exchange for safety. When fear overrules greed, safety is the goal, and cash is the instrument.
When people need to keep a lot of cash, ordinary forms of money are simply inadequate. Money, after all, is what people agree has value. Historically, money meant physical tokens: bills, coins, beads, wampum, or whatever struck people as valuable. But the U.S. and the world economy has become so large, so complex, and so inter-related that we need more money than can be conveniently represented by physical tokens. There is simply not enough gold, or dollar bills to stash under mattresses, anywhere in the world.
Hence, the special role of U.S. Treasury obligations. Yes, they are debts that the U.S. taxpayer owes to whomever. But they are also what most of the business world, the not-for-profit world, the retirement plan world -- in short, the entire financial system -- use instead of cash. Historically, they are as safe as cash and a lot more convenient. $9 trillion of the total of $14 trillion is U.S. debt obligations is right here in this country, used in just that way. A lot of the rest serves the same purpose elsewhere in the world.
For a few months, the debt ceiling debate in Congress created some doubt that Treasuries were as safe as ever. Maybe there would be a default: if not to bond holders, than to senior citizens, or soldiers, or someone else depending on a check from Uncle Sam. Faced with uncertainty, many investors did what people do when faced with uncertainty. That is, nothing. They held.
But as soon as the debt ceiling deal was signed, the uncertainty evaporated. And the stock selling frenzy really started. Treasuries are still the safest way to accommodate all that value. There isn't enough gold, or dollar bills to stuff in mattresses. And with fear on the ascent, investors want safety. So while stock princes swoon, Treasuries rallied. Investors will pay more for the safety of US debt while they flee the perceived risks of owning shares in the future performance of the private sector.
This means that the spat between the Obama administration and Standard & Poor's is a side show. One in which the pot is dissing the kettle. And vice versa.
Rating agencies exist to give investors their opinion on the likelihood that the debt holder will repay interest and principal in full and on time. So how has S&P done lately? Nate Silver excoriates S&P's track record on sovereign debt over the last five years, concluding that it is better to bet against S&P's ratings rather than bet on them. In its recent pronouncement on U.S. debt, S&P made a $2 trillion math error. As for their record on mortgage-backed securities, many analysts point out not just how "bad wrong" they were, but how much of our current national debt follows from the consequences of that mess and our societal costs to clean up after it.
So not the cleanest of pots. But what about the kettle?
In forming a rating opinion, it is not just fair, but important, to consider the management team running the company, municipality, or nation in question. Past performance is an important factor in forming an opinion on the likelihood that debt holders will be repaid. But the management teams of the present and the future will be the ones doing the repayment, not the past management team. So a rating agency not only can, but must, evaluate the impact of the management on the prospects of the business.
If the only factor in rating the U.S. national debt was the performance of Congress, we would deserve lower than junk bond status. The political polls agree.