Credit Ratings, Market Crashes, and the Cover Story

Posted on by Pastabagel and tagged , , , , . Bookmark the permalink.

Standard & Poor’s downgraded the US government’s credit from “Supermassively Awesome” to “Slightly Less Supermassively Awesome But Still Totally Great”. Markets responded as you’d expect, with a blind irrational panic, selling out of stocks and corporate debt and buying US Treasuries. One of the lesser known underlying assumptions of the Efficient Market Hypothesis is that under no circumstances do traders crush up Xanax and snort it off the asses of escorts. In other words, trying to understand the situation using the rational approach only gets you so far.

One of the things that was interesting about the ratings downgrade was the explicit mention by S&P of the political intransigence in Washington. Despite this, many pundits on both sides–because there are always only two sides to any issue so shut the hell up–tried to spin the story to their advantage. On the right, the finger was squarely pointed at Obama, on the left the finger was pointed at the tea party.

Let’s start chopping off fingers.

What is happening here is that the reasonable and sane minorities of both parties have been basically held hostage by their respective extreme wings for just a wee bit too long. On the far left, no one ever wants to cut Social Security or Medicare, and much to the contrary, they want to expand government healthcare programs to cover everyone. On the Tea Party far right, they incessantly chant the mantra of “no new taxes on the top X%.” And oddly, as X becomes smaller the chanting gets louder.

What the S&P story did, and what the markets are are doing generally by careening headlong into the abyss is establishing a cover story for the rational few in Congress. The last budget deal was the product of the lunatics running the asylum. Wall Street responds with what amounts to an open call for any responsible grown-ups to take charge.

The downgrade allows the old-line, non-Tea Party moderate Republicans to “concede to” (read: “push aggressively for”) tax increases on the rich and blame Wall Street. “If we want to get our credit rating back, we need to raise taxes, and as much as I hate to do so…” The centrist democrats likewise can push for more spending cuts in the big entitlement programs by calling the downgrade and weak 401k portfolios as a “soft tax” on the middle class.

I’m not suggesting that this is a conscious or a deliberate orchestration or manipulation of the credit rating agencies or the news the like, but rather how it will play out. A problem begets a solution, but if that solution fails or is dysfunctional, the failed solution begets a reaction.

The finger-pointing by pundits is pointless fingering. The rating downgrade does not embolden either party against the other. No one won, no one can claim to be vindicated. What it does is embolden the moderates against their fringes. They can point to this chaos as the original problem returning (spending grossly in excess of revenue with no possibility to grow out of it), but aggravated and mutated by the failed solution (no faith in Washington, and leadership without credibility).

So this becomes one of those rare situations where the parties voluntarily give up that with they held most dear. In a divided Congress, Democrats can’t increase taxes on the wealthy. But moderate Republicans can, so they will. And Republicans can’t cut entitlement spending, but moderate Democrats can. This news is just bad enough for the moderates to cut a deal with each other and outnumber (and outvote) the combined fringes. And when the base is outraged over the deal, the moderates can point to S&P or Wall Street and say “We had no choice.”

And what will that deal be? Hefty tax increases and steep cuts to entitlements. Everyone will feel the pain, everyone will suffer, everyone will lose. And they will cut this deal because regardless of their party affiliation, no one wants to watch the world burn.

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26 Responses to Credit Ratings, Market Crashes, and the Cover Story

  1. Guy Fox says:

    Pastabagel, you do snark well. :)

    It would be fantastic if this led to some rethinking of the two party state. Sure, there ain’t gonna be no blue ribbon commission to split the parties up a la Ma Bell, but if this sort of thing happens often enough, centrists from both sides might start to notice that they vote with each other more often than with their own side. A centrist party might be able to succeed in providing some alternatives where Nader, Biafra, Barr et al failed.

  2. max says:

    “If we want to get our credit rating back, we need to raise taxes, and as much as I hate to do so…”

    Why does the “reasonable and sane” approach always seem to enrich the already very wealthy? I’ll believe this when I see it.

  3. HP says:

    A) How does raising the taxes enrich the wealthy?

    B) How does nobody understand that we need to cut more and tax more? We’re in debt, and spending more than we’re making. That doesn’t work, period. Sure, we raised the debt ceiling…that’s like raising the blood alcohol limit to .15 to make drunk driving numbers go down. It’s not a solution.

  4. Methossa says:

    “Standard & Poor’s downgraded the US government’s credit from “Supermassively Awesome” to “Slightly Less Supermassively Awesome But Still Totally Great”. Markets responded as you’d expect, with a blind irrational panic, selling out of stocks and corporate debt and and buy US Treasuries.”

    Can someone explain this part to me? My understanding from what I’d read was that the selling of stocks was related to the GDP revisions more so than the S&P downgrade, and how the flocking to treasuries was proof that the downgrade was irrelevant.

    • DataShade says:

      To paraphrase Alone’s “no conspiracy where n>3 ever survives,” human motivation gets twisted and stupid enough when you hit “love triangle,” let alone trying to define a grand unification theory of market changes. I don’t have omniscience, but I read that Q1 GDP estimates were up a few percent; how would that trigger a sell-off in corporate stocks? Cash out now before … the cost of buying back into the game goes up?

      Don’t get lost in the minute details – of what was, after all, a narrative – and ignore the greater point: markets are only subject to rational predictions until you reach the point where irrational persons can move enough money around to make the market change; the chain’s only as strong as the weakest link.

      Inversely: you can safely make fantasticly accurate, if wholly irrational, predctions about market behavior when you examine the narrative and discern, not the conclusion, but the furthest chapter everyone has read.

  5. Pingback: An interesting take on the credit downgrade | Random Nuclear Strikes

  6. wanderinggambler says:

    Pastabagel, I agree with you for the most part, although we differ in dealing with entitlements. Social Security has little to do with the budgetary crisis we are currently experiencing. And furthermore, even if it did, it would be incredibly unfair to slash benefits for people who need them – especially because they’ve paid a great amount into the system already through the payroll tax.

    Personally, I think the Democrats are on the right side of history on this one despite their lack of political courage. The Republicans are chomping at the bit to destroy anything with FDR or LBJ’s imprint, whether it’d be Social Security, Medicare, or Medicaid.

    This current form of the Republican Party is obsessed with the cult of Ayn Rand. They are hell bent in destroying anything and everything related to government spending, not only because they feel it’s expensive, but also because it conflicts with everything they believe in regarding governmental power. To Republicans, any government spending is bad when the private sector can get involved. Private sector = more freedom, free market. Public sector = government waste, less freedom, limited market.

    It’s an asinine and cynical view to hold, that’s to be sure. The private sector simply cannot get involved in programs that do not lend itself to profit. Medicare and Social Security cannot possibly turn a profit because their entire existence is based on giving people aid at times they need it the most. That money is spent and the only way that money can grow is through taxation and interest.

    If it was up to all Republicans, everything would be run by the private sector. Including the military. Just look at Blackwater and the other defense contractors sucking the tit of government aid. They call it defense spending and corporate tax breaks. I call it socialism for the rich and powerful.

    • mwigdahl says:

      Huh?

      Medicare and Social Security cannot possibly turn a profit because their entire existence is based on giving people aid at times they need it the most.

      There is such a thing as an insurance industry, you realize, which both turns a profit and whose existence is based on giving people aid at times they need it the most.

      Spending, whether public or private, is worthwhile when you get good value out of it. The Republican axiom is that private enterprise is better at providing value for money than the government, because competition means that they have to provide value for money or their customers go elsewhere — an issue that government doesn’t have to deal with. Whether you believe that statement is true or not, that’s what’s impelling their position.

      Any governmental spending is enforced wealth redistribution in some way or another — the money comes from various tax sources, and it’s going to — what, exactly? Bridges in Alaska? Hiking trails in Chattanooga? Marginal social science research? Enforcement of an ever-expanding regulatory portfolio? It’s too easy to simply blather about cutting spending — a better approach is to make governmental spending provide solid value to the American people, and if it doesn’t provide proper value, don’t spend it.

      Our government (and government in general) is bad at this, because it’s very subject to backroom deals where you vote for my waste and I vote for yours, screwing the public while securing local political advantage for both of us. Companies that do this too much end up out of business.

    • mwigdahl says:

      Also:

      The private sector simply cannot get involved in programs that do not lend itself to profit.

      So trade unions don’t exist? Or are they for-profit?

      Then there’s that whole “non-profit organization” thing…

  7. wanderinggambler says:

    There is such a thing as an insurance industry, you realize, which both turns a profit and whose existence is based on giving people aid at times they need it the most.

    And how do the insurance industry make a great deal of their money? By charging people for services that they might not use. When you pay a insurance company 900 dollars a semester for college student insurance, but the odds of you getting beyond the 300 dollar deductible are slim – you’re taking a loss and the insurance company is getting a major gain. The only way the companies actually lose money is if the majority of their customers highly benefit from the services they paid for. Other than that, it’s a huge gain for each company.

    As to the rest of your post, yes you’re right, government spending is good when it has good value. That being said, what benefit does the private sector gain in creating mass transit? Probably not much. But what about the public sector? Well, there’s less traffic, less pollution, an improved ability to travel for people who may not own cars, etc. etc. Those effects of mass transit usage may not actually benefit an individual business/company that much for them to invest the funds to build/maintain the transit system.

    Plus, even if the private sector did get involved in a program like mass transit, the price would be outrageous to the point that people may not use it as well as they would if the prices were lower.

    According to many sources, America’s infrastructure is approaching failing grades. We need to pump 2.2 trillion dollars over the next 5 years just to get our bridges, roads, schools, sewer, and water systems back on track. You honestly think the private sector will pony up the funds to pay for all that? And allow the government to highly regulate (as they should) their usage?

    Fact is that these systems that need to be built need to exist not for profit, but for the common good. Only governments can properly address that, not private companies.

    • mwigdahl says:

      Sure, insurance charges premiums for coverage. If you don’t have a fire or don’t crash your car, you don’t receive any benefit. That’s part of the whole risk-mitigation aspect of insurance. In other words, that’s the whole point.

      Private competition is supposed to (in theory, note that it doesn’t always work this way) put price-competitive pressure on companies such that if one company tries to charge far more than a service is worth, other companies undercut them and business moves to the cheaper competitors. This works well in goods-based industries where it’s easy to compare value. It’s less easy when comparing insurance, where differences in coverage can be subtle and hidden in reams of documentation (one reason why regulation of these industries can be a good thing). It tends to fall down more in public services such as you mention later where competition is less feasible.

      Let’s look at Social Security as an example. You pay a “premium” — FICA tax. You receive a benefit — disability payments in certain cases, and a retirement benefit after a certain age. Currently the “premiums” are similar to how an insurance company would work — you pay a percentage of your income up to a certain cap.

      SS benefits, however, are not treated like insurance benefits. Whether you’re poor or rich, you get cash from the government when you retire. You’re not really insuring against destitution in retirement — you’re simply transferring a modicum of wealth from workers to the elderly. A true “social security insurance” would means-test benefits to avoid wasting money on those who don’t truly need it.

      That being said, what benefit does the private sector gain in creating mass transit?

      Look up the history of the railroads.

      Plus, even if the private sector did get involved in a program like mass transit, the price would be outrageous to the point that people may not use it as well as they would if the prices were lower.

      Like Amtrak?

      According to many sources, America’s infrastructure is approaching failing grades. We need to pump 2.2 trillion dollars over the next 5 years just to get our bridges, roads, schools, sewer, and water systems back on track. You honestly think the private sector will pony up the funds to pay for all that? And allow the government to highly regulate (as they should) their usage?

      I don’t know. It works for energy companies, but not everything works like the energy industry. I do know that the public sector hasn’t given a crap about the failing infrastructure until the bridges start collapsing, so I’m not sure you’re proving a point here.

      • DataShade says:
        That being said, what benefit does the private sector gain in creating mass transit?

        Look up the history of the railroads.</blockquote

        There's a huge difference between a freight system that can be repurposed to public transport (rails, highways) and discretely-public transport (subways, suburban streets, public buses).

        Like Amtrak?

        You need to clarify what you mean by that, because some people think Amtrak is awesome and some people think it’s a subsidized waste of government money, but … well, here’s a Wikipedia quote:
        “Popular support has allowed Amtrak to continue in operation longer than critics imagined, while financial results have made a return to private operation unfeasible.”

        • mwigdahl says:

          OK, then let’s talk buses — how about the case just this year where the PAT in Pittsburgh, due to the destitution of their state and county governments, decided to flat out discontinue several routes. Lenzner, a private bus service, stepped up with a proposal to maintain service.

          I like that blog article (and its comments) because it gives you both sides of the picture. PAT can’t even cover employee pay, let alone pensions, with their current level of funding. Yes, Lenzner will be providing a lower grade of service (higher fares, fewer discounts, etc.). But don’t forget that without Lenzner in place, those routes would be completely abandoned — PAT would provide no service at all in those areas. In addition, Lenzner will provide service without additional taxpayer expense — in fact, they’re paying PAT for the privilege of running the routes.

          Why would it not be feasible for PAT to raise fares for these more marginal routes, or to make other adjustments to ensure that they could provide the service that is their sole reason to exist? The first commenter on that blog post talks about Lenzner’s pricing scheme not doing anything for the “struggling / unemployed / welfare folks who need a bus to get to a doctor/ part-time job”. But I’d argue Lenzner’s service goes a damn sight farther for these folks than what PAT was planning to do to them.

          ***

          As far as Amtrak, what I was getting at was that although lots of people (in the Northeast, mostly) like Amtrak’s prices and service, the company bleeds money.

          The “wonderful” thing about Amtrak is that millions of people out West who would have to drive 500 miles to get to a train station served by Amtrak get the involuntary opportunity to subsidize convenient commuter travel in the Northeast. Of course, the favor is returned through farm subsidies and other rural boondoggles, and the net result is exactly what I said earlier — a pork-fest where politicians trade back-scratching votes that wink at government waste as long as it provides bennies they can point to during their re-election campaigns.

          At least when private companies provide service they have to make the business case that they can actually survive financially while doing so. The government is under no such inconvenient limitation as long as they can keep borrowing more (and more, and more) money.

  8. wanderinggambler says:

    As someone who used to take Amtrak all the time, I can tell you that (outside of sharing with freight trains) it is fantastic on the East Coast. Used to live in Washington and traveling to Philadelphia or New York is kinda great. It could be faster, but that’s thanks to Congress for failure to put in high speed rail where it should have been a decade ago.

    Amtrak is one of those quintessential programs that are created, then budget slashed by Congress, and then Republicans rip on for being a “worthless” or “wasteful” government program. Of course it’s not profitable in the West Coast when there’s only a handful of tracks amongst the thousands of miles in the American West.

    Go check out Philly, New York, Baltimore, and DC if you wanna see mass transit that works. If the rest of the country can design rail systems in that manner, you’ll see benefits to the areas surrounding them.

    The public sector hasn’t given a crap about failing infrastructure because they put it off to the side. The problem is that when localities and state governments fail to repair infrastructure; it actually costs more money to fix.

    • mwigdahl says:

      It could be faster, but that’s thanks to Congress for failure to put in high speed rail where it should have been a decade ago.

      Yes, that would be the same Congress that has implemented uneconomical requirements for high-speed rail since 1951, one of the reasons for the slow, lingering death of passenger rail in the first place. Luckily it seems that technology may be fixing that political problem in the near future.

      And Amtrak was never intended to be a permanently-subsidized governmental entity. From its Wikipedia article:

      The Nixon administration and many Washington insiders viewed the NRPC as a politically expedient way for the President and Congress to give passenger trains the one “last hurrah” demanded by the public. They expected Amtrak to quietly disappear as public interest waned. Proponents also hoped that government intervention would be brief, but their view was that Amtrak would soon support itself. Neither view has proved correct. Popular support has allowed Amtrak to continue in operation longer than critics imagined, while financial results have made a return to private operation unfeasible.

      Don’t get me wrong; I’m not a hard-core libertarian that believes that government has no place in providing services at all. There are areas — you’ve pointed some out — such as infrastructure, police protection, unemployment insurance, and public utilities, where the naive free-market approach doesn’t work well (or at all). Certainly those areas should continue to be serviced by the government and funded through taxation. But the sword cuts both ways; there are many areas where the private sector does a better real-world job of providing value for money, and in those areas the government, particularly the Federal government, should step back. They can then focus their (hopefully reduced) spending in more fruitful areas.

      • wanderinggambler says:

        Just curious, but what would you consider areas where the private sector could do better than the public sector?

        • mwigdahl says:

          I’m not talking about privatizing specific sectors of the economy like unemployment insurance or transportation, if that’s what you were getting at. I’m more interested in eliminating the wasteful and rent-seeking behaviors that occur when government contracts for goods or services, and that covers the whole span of public activities — from education to defense to transportation and beyond.

          There are myriad examples of these abuses available from links online — this one has some hair-curling ones: http://www.heritage.org/research/reports/2009/10/50-examples-of-government-waste#_edn7.

          Most of these abuses arise from the fact that there’s no inherent bottom-line motive for a government agency or a government bureaucrat to be a good steward of public funds. Nor is there always strong, effective accountability when abuses occur.

          You will say that Enron, BP, Union Carbide, Exxon, et al have perpetrated abuses as well, and you’ll be right. Corporate abuses primarily come from seeking to maximize profits. The human costs of safety and risk management all too often are undervalued due to the pressure to maximize profits, and severe catastrophes can result.

          Government’s abuses come from waste and inefficiency, and from excessive deference to the interests of the powerful who control the bureaucracy and the purse strings rather than focusing on efficiently performing their function. You usually don’t get acute crises from these abuses, unless you count the slow destruction of our economy through profligate overspending and debt overload.

          • wanderinggambler says:

            And I don’t disagree with you at all there. Certainly getting rid of the waste and fraud in government spending should be a priority for both political parties. You shouldn’t be able to spend the people’s money if you do a piss poor job at it.

          • DataShade says:

            OK, there’s government waste, and that waste is a problem. You didn’t answer the question, really, and there’s no solution there.

            That “the slow destruction of our economy” is tied 100% to “profligate overspending” and “debt overload” seems to be a matter of faith, rather than fact – and that’s not even considering how much economic mismanagement is the result of corporate or industry lobbyists pushing anti-competitive laws or exploiting regulatory capture. The state of Intellectual Property laws in USA is terrifyingly bad, but that’s a conversation worth devoting an entire site to.

          • mwigdahl says:

            Blaming lobbyists for bad legislation and regulation is a cop-out. The rubber meets the road on the floor of the House and Senate. They are the ones that make the choices to implement policy. You will always have special interests (including non-corporate activists such as environmentalists, etc.) pushing their agendas — it’s supposedly the job of government to balance those agendas and provide strong, far-sighted leadership.

            A more accurate restatement of what you said would be “and that’s not even considering how much economic mismanagement is the result of elected officials bending to the pressure of outside interests with sweetheart deals and special treatment.”

            No argument on the state of intellectual property legislation. It really is terrifyingly bad.

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