U.S. Debt Outlook: Downgrade to Negative

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Traders work on the floor on the New York Stock Exchange on April 18, 2011 in New York City following news that Standard and Poor's had cut its long-term outlook on U.S. debt to negative.

Welcome to Politics Bites, where every afternoon at It's A Free Country, we bring you the unmissable quotes from the morning's political conversations on WNYC. Today on the Brian Lehrer Show, Simon Johnson, former chief economist of the International Monetary Fund and professor at the MIT Sloan School of Management, talked about why Standard & Poor's downgraded the outlook for U.S. debt to "negative" and how that factors into the ongoing battle over the national debt. Washington Post Economic Policy Reporter reporter Lori Montgomery joined the conversation to talk about how the S&P rating might change the political landscape of debt in Washington.

'Welcome to Capitalism'

The United States' sovereign credit rating remains desirable, but after S&P downgraded our long-term outlook to "negative" yesterday—essentially saying that our rating will drop sometime in the near future, should we fail to address our debt — the stock market responded with similar pessimism.

However, Simon Johnson says there's ample reason to be suspicious of S&P's findings—or, at least, to take them with a big grain of salt.

They don't have a lot of credibility left after totally blowing all major calls of the past decade...The chance that the United States would not pay its debts after more than 200 years of being the best creditor in the world, that chance exists. It is quite remote in my assessment. But there's no question that S&P is trying to swing the other way and trying to get some attention from the left and right, and it's obviously working.

Since 2000, S&P had given out AAA ratings to several financial institutions, ratings that were exposed by the crisis as being largely bunk. In shaking off their prior flubs, S&P may be overcompensating by paying excessive attention to the federal government.

Diligence is appreciated, but this does little to allay worries that S&P can't be trusted. Where the agency once may have been lax in order to bolster profits, now it's equally likely that it's cracking down for the sake of appearances. Johnson said that in both cases, the facts take a back seat.

Welcome to capitalism. This is the business they're in. They want to have attention, curry favor, and in my assessment this is an exaggerated document.

Our debt is unsustainable...now what?

If investors and creditors lose their faith in the United States' ability to pay off its debts, the global community may decide to take its money elsewhere. Domestic interest rates—the price of borrowing in the U.S.—would climb, dealing another blow to the delicate economic recovery.

All roads lead to the debt problem, and what our government will do to correct fiscal course. Should we take drastic action as soon as possible to get our debt under control and avoid a ratings bust? Not so fast, said Simon Johnson, who held up the effects of Britain's belt-tightening as a cautionary tale to slash-and-burn deficit hawks.

They had a budget issue, a financial crisis, and the conservative reaction in the new government is excessively speedy in their fiscal adjustment, meaning it's slowed down the economy. I think they had more time and could have put a sensible, responsible adjustment program in place...[For the U.S.] there are many options still on the table, including relatively modest, well-planned changes to both spending and taxes that could be put into play over a number of years and would not significantly slow the economy at all.

Lori Montgomery agreed that there was plenty of evidence to suggest the U.S. take a more measured approach to dealing with debt, and said that complicates a signature thrust of the Republican agenda.

The weak economy argues against beginning any kind of austerity program until 2012 or 2013 at the earliest. We've seen from an array of independent fiscal commissions that we shouldn't pull back on the accelerator just yet. Republicans obviously disagree because they promised voters they would cut spending.

Republicans' revenue problem

Absent significant spending cuts, which could hurt the economy, confronting deficits requires raising tax revenue. That's the opposite of what Congressional Republicans ran on in their sweeping 2010 victories. But in the hangover from election night, said Lori Montgomery, certain realities have set in. Conservative Republicans like Reps. Tom Coburn and Saxby Chambliss have said that taxes need to be back on the table.

There's a clever way to go about doing that, though. Montgomery made the point that raising tax revenue is not the same thing as raising tax rates, and that you can do the latter without having to use a slew of politically toxic phrases.

If you're going to reform the tax code to lower rates and get rid of deductions and breaks, you can mask the fact that the tax code would actually collect more in revenue because you're giving people a break in their rates. If that sort of alchemy can be achieved, I think Republicans could support that.

Dropping the ball

Simon Johnson said that for all the concern about our government's fiscal policy, it's the private financial sector that we should be watching. That's the same industry that S&P should have done a better job of patrolling prior to the 2008 meltdown—and the industry nobody looks to in the debt crisis blame game.

Look at how much debt we've increased as a result of the financial crisis, as a result of what banks were allowed to do, as a result of a highly risky financial system. Compare the Congressional Budget Office forecast for debt in 2018, the forecast they put out in 2008 versus the one they put out in January: that's a $10 trillion increase in debt, a 50 percent increase in our debt to GDP ratio because of what banks did. Did S&P mention in its document, does Paul Ryan talk about, does President Obama talk about the financial system as posing the most important pressing fiscal risk to the United States? No, they don't. S&P has blown another call on that; Ryan and Obama need to wake up and look hard at what really has pushed up our debt to GDP ratio.