Sunday, August 07, 2011

Downgrade reading

This is the best piece I've seen on what institutional investors expect from the market tonight and Monday morning.  Binyamin Appelbaum's piece is a decent one with a bigger picture.

We don't so much have to worry about U.S. banks or money market funds. Most rules were written assuming that Treasuries would always be AAA, or rely on the fact that 2/3 major rating agencies still have it at AAA. And money market funds hold Treasury bills, which were not part of the downgrade.

Treasury loudly objects to the downgrade, harping on the $2 trillion math error S&P acknowledged. But it's ridiculous to say that if S&P had gotten it right it would have seen that the U.S. debt/GDP ratio was "much more stable" in 2021 (S&P was only off by 8%... do you think 8% makes a huge difference?)

What matters is not 2021, but 2041.  We issue 30-year bonds.  Debt is projected to be 87% of GDP in 2041, according to the CBO's baseline.  And that assumes higher income, payroll, dividends, and capital gains taxes from 2012 to 2041 than would be politically palatable.  It also assumes no changes to the Affordable Care Act, and that it bends the cost curve as CBO projects.

Congress has shown itself unwilling to take the measures necessary to address the entitlement problem, and hence, long-run deficits. S&P is highly skeptical that the U.S. will raise taxes as is currently on U.S. books.  Why not?

CBO's alternative fiscal scenario, which assumes that Congress does what it always does projects debt-to-GDP over 200% in 2041.  Knowing that, why shouldn't the U.S. be downgraded?

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