About the Author: David Beers is a senior fellow at the Center for Financial Stability, a New York-based think tank. He led the S&P sovereign rating team between 1995 and 2011. His views expressed here do not necessarily reflect those of his current or past employers.
In August 2011,
became the first major rating company to downgrade US debt, following a political debt and spending crisis. Ten years later, S & P’s decision is still controversial. My fellow rating committee members and I expected criticism when we made the decision. We have plenty. We have been attacked by officials in Washington and across the country, by sections of the banking and investment communities, and even by ordinary American citizens.
It has been a difficult time for all of the S&P analysts mentioned in the press release. Once the fury was over, I traveled to Europe, Canada and East Asia for meetings that I had previously postponed. I was struck everywhere that the people I met were much less critical of the degradation of S&P than the people in the United States. Many even told me that they agreed with us.
Looking back, I still think the downgrade was the right decision, and supported by events since then.
First, consider S & P’s assumptions behind the rating downgrade highlighted in its press releases. Basically there were two. One concerned the trajectory of public debt. The committee’s preferred measure, net public debt, combines U.S. federal government bonds with those of state and local governments, net of their financial assets. We have considered (and still consider) this metric to be the best for comparing sovereign debt due to their varied and often more centralized fiscal arrangements compared to that of the United States.
What were S & P’s expectations on public debt and how did they play out? In fact, the ex post trajectory of the ratio of US net government debt to GDP is very much in line with what S&P assumed at the time, which, in turn, was based on an analysis by the independent Congressional Budget Office. These projections showed net debt reaching 79% of GDP in 2015; the actual result was 80.7%. Over a ten-year horizon, S&P expects net debt to reach 85% of GDP by 2021. below the 103% result from last year, which was strongly affected by the outbreak of Covid-19. However, by 2019, net debt had already reached 83% of GDP and would have increased higher since then in the absence of the pandemic. Thus, leaving aside the extraordinary budgetary impact of Covid, S&P understood the underlying dynamics of public debt in 2011.
What to say about the Politics dimensions of US fiscal policy? In accordance with his rating criteria, S & P’s ratings also reflect its views on a sovereign’s political stability. There shouldn’t be much controversy about this, at least among credit analysts. After all, political dynamics influence fiscal policy. At the time of the 2011 downgrade, S&P pointed to the impasse on fiscal policy between the Democratic Obama administration and the Republican majority in the House of Representatives. S&P cited the fight to raise the federal debt ceiling, a feature of fiscal policy unique to the United States, but its larger point was the lack of bipartisan consensus on fiscal priorities.
How does the traffic jam in 2011 compare to what we are seeing now? By any reasonable standard, the political polarization in the United States is much worse. On a range of key issues, it’s harder than ever to concoct multi-party majorities at the Congress of My Life, which spans 13 presidencies. And it is no coincidence that we also have the most polarized electorate of modern times. How else can we describe a state of affairs where as much as 70% of republicans do not accept the certified results of the 2020 presidential election, and the main political parties are plagued by the extremes on the right or on the left? Today, the central field is a more lonely place in American politics than it was ten years ago. So S & P’s concerns on this issue also resonate today.
Finally, let’s look at a snapshot of running views of the financial markets on the solvency of the United States. A good metric, separate from (but not necessarily unaffected by) credit ratings is the five-year credit default swap market.. The CDS market assesses the perceived credit risks of participating investors. Since last Friday, for 5-year CDS swaps the United States ranked 10th in basis points, behind new European rulers. This includes one (the UK) with a lower S&P rating and the others, mostly eurozone sovereigns, with lower, the same or (like Germany’s) higher credit ratings.
I remain convinced that the downgrade of the US credit rating in 2011 was the right decision. Fiscal and political developments since then confirm S & P’s judgment, as do investors’ views on the CDS market. On current trends, we should expect further downgrades from the three major rating companies. One of them is Fitch Ratings, which assigned a negative outlook to its AAA rating of the United States last year. But there is a bigger concern here: the health of America’s democracy. For all of us, much more depends on America’s faltering political experience than just its credit ratings.
Guest comments like this are written by authors outside of the Barron’s and MarketWatch newsroom. They reflect the views and opinions of the authors. Submit comments and other comments to [email protected]