Moody’s Mulls Downgrading U.S. Debt
The U.S. isn’t Greece. Yet.
Moody’s is no longer so sure about the quality of Uncle Sam’s debt. Reports the Christian Science Monitor:
The US needs to make significant government spending cuts or else risk losing its gold-plated credit rating that has made extensive borrowing so affordable, Moody’s Investor Service said late Monday.
The announcement was a sobering warning that the country’s burgeoning debt has weakened the country’s economic standing, and that US Treasury Bonds, traditionally a bullet-proof investment, could lose their sterling Aaa-rating if Washington cannot control its federal debt.
If Moody’s were to downgrade the country’s rating, the impact could be severe. It would signal to lenders worldwide that the US is no longer one of the safest places to invest money.
That, in turn, would threaten the country’s ability to borrow freely and extensively from other countries on favorable terms. Investors would likely demand a higher interest rate to finance US debt, which would push federal debt higher still.
“There’s a profound effect in this announcement,” says Max Fraad Wolff, a professor of economics at New School University in New York. “The US has always been the gold standard … and this begins to signal a fall or weakness in US global economic position. That’s a bit like a sea change.”
Obviously we are long overdue for some fiscal responsibility in Washington. And that means cutting spending across the board. Lawmakers might start by considering what programs are authorized by the Constitution–and the far larger number which represent unconstitutional political power grabs.
Moody’s Caves In to Political Pressure on Municipal Bonds
Moody’s has announced that it will change its methods for rating debt issued by state and local governments. Politicians have argued that its current ratings ignore the historically low default rate of municipal bonds, resulting in higher interest rates being paid on muni debt, or so argue the politicians.
First this argument ignores that the market determines the cost of borrowing, not the rating. And while ratings are considered by market participants, one can easily find similarly rated bonds that trade at different yields.
Second, while ratings should give some weight to historical performance, far more weight should be given to expected future performance. Regardless of how say California-issued debt has performed in the past, does anyone doubt that California, or many other municipalities, are in fiscal straights right now?
Last and not least, politicians have no business telling rating agencies how to handle different types of investments. We’ve been down this road before with Fannie Mae and Freddie Mac. During drafting of GSE reform bills in the past, politicians put constant pressure on the rating agencies to maintain Fannie and Freddie’s AAA status.
The gaming over muni ratings illustrates all the more why we need to end the rating agencies govt created monopoly. As long as govt has imposed a system protecting the rating agencies from market pressures, those agencies will bend to the will of politicians in order to protect that status. As Fannie and Freddie have demonstrated, it ends up being the taxpayers and the investors who ultimately pay for this political meddling.
Wednesday Links
- A real stimulus: To create jobs, repeal the corporate-income tax.
- As if times weren’t hard enough: The individual mandate on health insurance would impose high implicit taxes on low-wage workers. For more on this, read the new Cato study on burdens the health care legislation will place on the poor.
- Hot off the press: New issue of Regulation magazine looks at lessons from the financial crisis and property rights.
- Even though the government is running massive deficits, interest rates and inflation are low. So, what’s the problem?
- Podcast: “Bernanke’s Conceit” featuring Mark A. Calabria.
The Fed and Policy Uncertainty
How and when should the Fed unwind the enormous monetary expansion it undertook in response to the financial crisis and recession? The WSJ reports [$]:
As the Federal Reserve’s next meeting approaches in early November, an internal debate is brewing about how and when to signal the possibility of interest-rate increases.
The Fed has said since March that it will keep rates very low for an “extended period.” Long before it raises rates, however, it will need to change that public signal to financial markets.
Because the recovery is so young and is expected to be so weak, many central bank officials are comfortable, for now, keeping rates very low. But they are beginning to strategize about how to walk away from the “extended period” language.
My suggestion is that the Fed announce a path of gradual increases in the federal funds rate, say beginning next year and lasting for two years, until the rate is at some “normal level.”
This approach is different than what the Fed is likely to undertake; it will probably want to maximize “discretion,” the ability to adjust on the fly as conditions unfold.
My approach maximizes predictability and reassurance: it commits the Fed to shrinking the money supply and heading off future inflation. This reassures markets and takes substantial uncertainty out of the picture.
The problem with my approach is the pre-commitment: everyone knows the Fed could abandon a pre-announced path.
But such an announcement might still give markets useful guidance, and the Fed would know that any deviation would itself upset markets, and this might encourage adherence to the pre-commitment.
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