Economist Dean Bellows on the logic of the debt ceiling increase and possible default. Dean Bellows argues that the downgrade of the United States' credit rating did not cause the recent losses on Wall Street: Time to beat up on really
August 11, 2011

Economist Dean Bellows on the logic of the debt ceiling increase and possible default.

Dean Bellows argues that the downgrade of the United States' credit rating did not cause the recent losses on Wall Street:

Time to beat up on really really bad news reporting. The stock market doesn't tell people why it does what it does. We have commentators who bloviate on what they think caused the market to rise or fall, but they don't really know and they could be completely wrong.

That is why it was incredibly irresponsible for NPR to tell listeners in its top of the hour news segment that the market plunged because Standard and Poor's downgrade of U.S. debt. NPR does not know this to be true and it certainly is not obviously the case.

The market that should have been most immediately affected by the S&P downgrade was the U.S. bond market. However bond prices soared in the trading immediately following the downgrade and continued to rise through Wednesday. If there was greater fear that the U.S. would default because of the downgrade, then bond prices should have plunged as investors demanded a higher risk premium. This did not happen.

The most obvious alternative explanation for the plunge in the market is the risk that the euro could break up as the debt crisis spread from relatively countries like Greece and Ireland, to the euro zone giants, Spain and Italy. The prospect of a euro zone break-up raises a real risk of a Lehman-type freeze up of the world financial system. It is far more plausible that this prospect led to the plunge in the stock market than the downgrade by one of three major credit rating agencies.

Bellows and others, including Acting Assistant Secretary for Economic Policy John Bellows, have pointed out that the original rationale S&P used to argue for the downgrade was based on $2 trillion calculation error. When this error was pointed out to them BEFORE the downgrade was issued, S&P effectively ignored it. According to Bellows:

The impact of this mistake was to dramatically overstate projected deficits—by $2 trillion over 10 years. As anybody who has followed the fiscal discussions knows, a change of this magnitude is very significant. Nonetheless, S&P did not believe a mistake of this magnitude was significant enough to warrant reconsidering their judgment, or even significant enough to warrant another day to carefully re-evaluate their analysis.

S&P acknowledged this error – in private conversations with Treasury on Friday afternoon and then publicly early Saturday morning. In the interim, they chose to issue a downgrade of the US credit rating.

Independent of this error, there is no justifiable rationale for downgrading the debt of the United States. There are millions of investors around the globe that trade Treasury securities. They assess our creditworthiness every minute of every day, and their collective judgment is that the U.S. has the means and political will to make good on its obligations. The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raise fundamental questions about the credibility and integrity of S&P’s ratings action.

When further confronted over the decision to make the downgrade, S&P representatives, talked about their decision being transparent, while hiding information about the decision:

S&P won’t say who at the company made the decision to downgrade U.S. debt from its AAA rating to AA+, only that it was made by a panel of five to nine executives. But company president Deven Sharma defended S&P in a CNBC interview yesterday.

Said Sharma: “Our role is to call the risks effectively and transparently, and that’s what we have done.”

S&P's response to a math error? Acknowledge it and then keep the bad decision based on the error. Their response to questions about that decision? Claim to be transparent while saying that the decision was made by an indeterminate number of anonymous people.

Something smells fishy...

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