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John Fullerton Headshot

Only One Notch, S&P?

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I recall when JPMorgan lost its AAA rating. Those of us who had worked there a long time felt the gloom of losing our specialness. Though the rating agencies were right, the truth hurt. Egos were stung. But, the rating agencies were late, as they almost always are.

The downgrade of U.S. sovereign debt is no different. Every rational, objective observer must conclude that this downgrade comes as "too little, too late." Apparently, neither Tim Geithner, nor even Warren Buffett, can remain objective in the face of a downgrade. Nor could the senior management of JPMorgan when it saw the same fate. Blame the messenger is a time tested strategy.

The headline of the S&P full press release on the downgrade reads:

United States of America Long-Term Rating Lowered To 'AA+' Due To Political Risks, Rising Debt Burden; Outlook Negative

The press release the rating agencies should have released on December 18, 2010, the day after Congress approved an extension of the Bush Tax cuts, reads as follows:

United States of America Long-Term Rating Lowered Two Notches to 'AA' Due to Political Risks, Weak Leadership, Rising Debt Burden, Virtually Unlimited Contingent Liabilities, and New Constraints on Long Term Growth; Outlook Negative  December 18, 2010
  • 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, reinforced by the President's capitulation on extending the Bush Tax cuts for even the wealthiest 1% of taxpayers, that Congress and the Administration are still not taking seriously the long term fiscal imbalances resulting from well understood demographic changes facing the nation. These risks are compounded by the1.3 trillion (and growing) hole created by the Bush tax cuts, an estimated3 trillion (including long-term health benefits and interest burdens) to fight two wars, and the impact of the financial-industry-induced balance sheet recession which has exploded annual deficits to unsustainable levels.
  • More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have dangerously weakened. We observe a nation that is without strong leadership and is virtually ungovernable at a time when restoring economic vibrancy and long-term fiscal prudence is essential.
  • Furthermore, the recent financial crisis, the weak government response in addressing meaningful financial reform, and the ongoing success of the financial industry in weakening reform necessitate a fundamental rethinking of the contingent liability associated with the government's debt rating.  Nothing has changed that will prevent the government from having to underwrite the liabilities of the still oversized, misguided, and irresponsible financial industry at a time when its ability to do so has been severely weakened.
  • The outlook on the long-term rating is negative. We might lower the long-term rating to 'AA-' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new  fiscal pressures during the period result in a higher general government  debt trajectory than we currently assume in our base case. 
  • Our base-case of stable 3% long-term growth already looks suspect, and our low case fails to anticipate any future crises despite the significant risk of a euro-zone breakup, an increasingly uncertain planning environment, and a growing likelihood that natural resource limits to growth will come into conflict long-term economic growth.
*We note the irony of one of the rating agencies acting responsibly given the role our recent failures have had in leading to this action today. Sovereign ratings are pretty easy compared to CDO squareds, though, and we have no doubt this is the correct assessment. Trust us. History will show we are late and timid on this rating like we always are.