Why the Standard & Poor’s Threat Of a U.S. Credit Rating Downgrade Matters

by Pejman Yousefzadeh on April 19, 2011

Lots of blogospheric Sturm und Drang–example here–on why we are not supposed to take the S&P threat seriously. Megan McArdle blasts the “deficits don’t matter” crowd in a nice way, but make no mistake–she blasts them:

S&P is certainly entitled to their opinion–for all their failings, they do spend a great deal of time analyzing government finances, much more than James [Fallows] or I do.  You make think that their opinion is crap, in which case you should say so–but I cannot understand why we’d quibble with the format in which that opinion is issued.  S&P has been issuing these sorts of things for a long time, and I don’t think it would make much difference if they started doing so in blog form.

Moreover, their opinion does actually matter, since previous rounds of financial regulation have embedded financial agency ratings deep in the structure of our financial markets.  Institutions like insurance companies have strict regulations about the quality of the assets they can buy, and S&P ratings, among other things, are the proxy that we use to judge credit quality.  If James or I scream that the US debt picture is unsustainable, we will not move markets.  If S&P downgrades US debt, this will trigger a sell-off, even if the people selling disagree with their assessment.  Nor is there any easy way around this; the nature of regulation is to require hard metrics and bright lines, even if those metrics aren’t very good.

And I cannot disagree too strongly with the notion that the US can’t default because we can always print money.  It isn’t even technically true–Zimbabwe eventually ran out of hard currency to buy the ink it needed to print the money to sustain its hyperinflation.

It’s amazing–and scary–to see how many people are busy trying to pretend that there isn’t a fiscal problem. If those same people put in half as much energy in trying to solve the problem, folks like me would sleep easier at night.

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