The S and P Downgrade Decision Stinks of Politics and Corruption.

Yves Smith at Naked Capitalism (an unusually good source of very in-depth, timely commentary) offers some strong evidence and analysis of how the S&P decision to downgrade the U.S. debt stinks.  I’ve already talked about how it’s really irrelevant at the economic level and how it’s not likely to change things substantially.  I’ve also written about how S&P doesn’t have a very good track record.

But Yves, who has extensive connections on Wall Street and in the trading/banking community, brings two other aspects to light. First, this downgrade, along with the threatened downgrade of a few state governments earlier this past week, was leaked before the announcement.  The proper procedure is to make such announcements after the close of markets and to not allow any leaks.  Leaks constitute insider information.  They let selected individuals make profits because they know what’s coming.  For example, as Yves suggests, if some traders or banks or others were told in advance, even just a few hours ahead that a downgrade announcement would be made, they could make millions.  How?  They could either place orders, particularly using derivatives, in anticipation of the move.  After the prices of bonds change due to the announcement, you sell.  But there’s a simpler way.  Just place an investment bet using the derivatives that based on the volume of trading.  Any announcement is certain to trigger a higher volume of trading.  Leaking news of announcements is an easy way for S&P to enrich it’s favorite friends. Yves notes:

Treasury yields fell 50 basis points last week despite the risk of a downgrade being very well telegraphed. S&P had asked for $4 trillion in deficit reductions (it tried disavowing that number) and made it clear it was going off to brood and might take action. And this market response took place with S&P leaking like a sieve. Not only was Twitter alight early on Friday with rumors of the downgrade, but some parties purportedly got the memo earlier in the week. From a credible source via e-mail:

Good friend passed on a note from a hedge-funder who thinks the S&P not only fudged its figures for today’s downgrade, but leaked it in-advance earlier this week to a few hedge fund insiders who made a killing off it. That would square with the fake “states face bankruptcy” panic scam earlier this year, which made a few people a lot of fast money.

I assume they did not make a directional bet but went long vol.

So what if bond yields go up 50 basis points on Monday, which is normally a monster move? It just puts us back to where we were last Monday.

So why didn’t investors dump Treasuries with this threat hanging over the market’s head? Maybe investors have wised up and realize the ratings are worthless (more on that shortly).

Yves goes on to explain a bigger, stinkier aspect to the downgrade.  It’s politics and a possible we’ll-help-Republicans-if-they-protect-us deal between Republicans and S&P.

Jane Hamsher highlights the hypocrisy of the S&P rating, since it shifted from its 2010 rationale of demographic stress to a February 2011 focus on entitlements. And it didn’t bat an eye at the $2.6 trillion deficit-increasing Bush tax cut extension at year end 2010. More from Hamsher:

Neither Moody’s nor Fitch downgraded US debt at this time. And S&P can’t quite come up with a consistent answer about why they are out there by themselves. It’s like they looked at a public opinion poll, decided that there was no way anyone would argue with “partisan bickering” as a justification, and crossed their fingers that nobody would actually question what it is that they were justifying.

S&P is playing footsie with the Republicans, who are passing bills to relieve them of the legal liabilities that Dodd-Frank exposes them to — even as the SEC is investigating S&P for fraud in the mortgage meltdown.

Some said that S&P wouldn’t dare downgrade the US debt. But it was all over four days ago when Pimco’s Mohammed El-Erian said that S&P was “under pressure” on the US rating.

If you didn’t happen to catch Devan Sharma’s testimony before the House Financial Services Committee last week, this was what he said:

As Dodd-Frank rulemaking progresses, we believe it is critical that new regulations preserve the ability of NRSROs to make their own analytical decisions without fear that those decisions will be later second-guessed if the future does not turn out to be as anticipate or that in publishing a potential controversial view, they will expose themselves to regulatory retaliation.

Pressures of that sort could only undermine the significant progress we believe has been made over the years by rating agencies and regulators alike to provide the market with transparent, quality and generally independent views about the credit-worthiness of issuers and their securities. I thank you for the opportunity to participate in the hearing and I would be happy to answer any questions you may have.

“Pressure.”

That’s what Rep. Randy Neugebauer, chairman of the House Financial Services Subcommittee said on April 29, when he requested documents from the administration: Treasury officials “may have exerted too much pressure on S&P.” The Republicans were already laying the tracks for S&P’s defense in April.

Here are a few more dots to connect the timeline:

April 18: Mitt Romney: “The Obama presidency was downgraded today.”
April 20: Mitt Romney: “Standard & Poor’s, one of the rating agencies, just downgraded their view of the future for America…If you will, they downgraded the Obama presidency.”
July 15: WSJ — “The Obama downgrade.”

They’ve been cooking this one for a while. S&P will defend themselves from the accusation of overt partisan manipulation by claiming the Treasury “pressured” them not to downgrade US debt. The media will focus on what Geithner did or didn’t say during his meetings with S&P in March and April. Nobody will ask about the ridiculous excuses S&P has made for the downgrades, or the fact that they are trying to wreck the American economy just as they did the British economy by playing God with their austerity prescriptions.

People are focused on the market implications of the downgrade, but that isn’t what this is about. It’s about a President who will now be relentlessly tagged with responsibility for a rating given by a disgraced organization whose victims should have liquidated them long ago.

As Politico reported, White House officials feared a downgrade more than they feared default.

This stinks.  I have only quoted the a small part of this story.  I urge readers to go to nakedCapitalism and read the whole article.  This whole downgrade by S&P is politics.  S&P is being used (quite enthusiastically with their cooperation) by bankers and politicians who desire to dismantle the social democratic state.

 

 

 

Republicans: What Deficit? We Need to Stop Unions First.

Michael Perelman reports with NPR’s help about how the Republicans shut down the FAA in mid-July for nearly 4 weeks as a favor to Delta Airlines.  Basically, in July the law authorizing the FAA, the agency that supervises airport and airline safety,including flight controllers, expired.  Normally this would be a routine renewal effort.  Even in somewhat testy times with a split Congress, there would normally be an agreement on a stop-gap measure.  Not this year and not with this House.

The FAA was shut down because of a partisan dispute.  The basic issue was supposed to be the Republican demand that the agency save $16 million by ceasing to subsidize 13 airports with relatively little demand.  Yes, the airports were in Democratic strongholds.

NPR’s Brian Naylor reported that the airports were a bargaining chip.  The real issue was the threat that union power posed for Delta.  The National Mediation Board rejected a practice that counted required a union to win more than half the eligible votes rather than half of the votes cast.

Delta, the only non-union airline, got the Republican bill to include language overturning the National Mediation Board decision.  Since the House leadership refused to budge, the FAA shut down, leaving the government unable to collect $30 million per day in taxes.  Patriotically, most of the airlines continued to collect the tax in the form of higher fares.  However, these “job creators” kept the money so that they could help the economy.  Besides, the government could make up the lost taxes with still more tax cuts.

This happened two weeks before the supposed debt-ceiling deadline.  At the time, the Republicans were claiming that the deficit and government spending were out of control, threatened the nation, and had to be reduced.  So what did they do?  Rather than compromise, they decided to stop the government from collecting $30 million in ticket taxes per day!  In addition they put 4,000 government workers out of  a job!  What was worth costing the government so much money and making the deficit so much worse?  They wanted to save $16 million per year by closing 13 airports in Democratic districts.  Oh, and they also wanted to change the rules on unionization to protect big-donor Delta Airlines.  Best government money can buy.

 

This Is No Movie Folks. It’s Real and It’s Scary.

I don’t enjoy scary movies. Never have.  I also don’t enjoy scary “amusement” park rides.*  I know I’m kind of a fluke in our U.S. culture this way.  I just find that there’s enough excitement, thrills, and fright in the real world if you just open your eyes.

An example of real world things to be scared of is the current debate  childish tantrum in Washington over increasing the debt limit. I’ll admit I haven’t taken it seriously until now.  A couple months ago I called it Kabuki Theatre of the Absurd. The law itself, the debt “ceiling” law, is absurd.  It is also redundant. Raising the debt ceiling should be a like sending a form letter.  Routine. Perfunctory. The law should be simply done away with. If Congress doesn’t want to borrow more money then the time and place to make that point constitutionally is when the budget is adopted.

The Republicans and Tea Party types were unable to accomplish their goals of gutting Social Security, Medicare, and other programs when the budget bill was debated last March-April.  They simply didn’t have the political support and they couldn’t agree on just who to cut.  So instead of doing the constitutional thing and either win more elections and gain seats (they actually lost a special election in May because of their plans to cut Social Security), or waiting until the next budget for next year, they’re trying to accomplish their goals under a subterfuge.  It’s not about the debt. It’s not about the deficit.  If it were about debt, deficits, and “fiscal responsibility”, then closing tax loopholes for high-income folks like hedge fund managers and the commodity speculators that drive up oil prices would be an option.  But the Republicans and Tea Partiers have expressly stated that even closing a tax loophole is unacceptable.  Only spending cuts are acceptable.  So the truth is it’s not about “fiscal responsibility”.  It’s about eliminating government programs that people want as the New York Times explains today (possible paywall on link).

So back to the debate tantrums being thrown in Washington. I still expect there to be a last-minute deal when powerful folks on Wall Street give the call to their friends in D.C. and tell ’em to knock it off and do it. In the meantime, the Republicans, Tea Party types, and Obama administration are playing a game of chicken.  Except that this is a bit different from movie versions of chicken.  Jeff Frankels provides an excellent analysis. The problem is three-fold: it’s not movie fantasy – it’s real, the folks in the Republican car aren’t rational and are fighting among themselves, and when these cars go over the cliff there’s a good chance they take our entire economy with them. Quoting Jeff:

In the 1955 movie Rebel Without a Cause, James Dean and a teenage rival race two cars to the edge of a cliff in a game of chicken.  Both intend to jump out at the last moment.  But the other guy miscalculates, and goes over the cliff with the car.

This is the game that is being played out in Washington this month over the debt ceiling.  The chance is at least 1/4 that the result will be similarly disastrous.

The game is not symmetric.  The Republicans are the ones who are miscalculating.   Evidently they are confident of prevailing:  they rejected the President’s offer, even though he was willing to cut entitlement programs.

The situation is complicated because there are a number of different people crammed into the Republican car.    There is one guy who is obsessed with the theory that, come August 3, the federal government could retain its top credit rating if it continued to service its debt by ceasing payment on its other bills.  But this would mean failing to honor legal obligations that have already been incurred (paying suppliers for paper clips that have already been bought, paying soldiers their wages for last month’s service, sending social security recipients their checks, etc.).  This is like observing that the cliff is not a 90 degree drop-off, but only 110 degrees.   It doesn’t matter: the car would still go crashing into the ocean far below.   The government’s credit would still be downgraded and global investors would still demand higher interest rates to hold US treasuries, probably on a long-term basis.

There are other guys (and gals) in the car who are even more delusional.   They are dead set on a policy of immediately eliminating the budget deficit (e.g., those opposed to raising the debt ceiling no matter what, or those campaigning for a balanced budget amendment), and doing it primarily by cutting nondefense discretionary spending.  This is literally impossible, arithmetically.  But they honestly don’t know this.   It is as if they were insisting that the car can fly.   Sometimes it can be a good bargaining position to adopt a very extreme position.  But if you are demanding that the car flies, you are not going to get your way no matter how determined you are.

It seems likely that the man in the driver’s seat – House Speaker John Boehner – does realize that his fellow passengers don’t have the facts quite right.   But there is also a game of chicken going onwithin the Republican car.  The crazies have said they will oppose in the next Republican primary election any congressman who votes to raise the debt ceiling or to raise tax revenues.   (Yes, they think they would support someone who would eliminate the budget deficit primarily by cutting non-defense discretionary spending; but remember, this is arithmetically impossible.)   The guy who is riding shot-gun in the car – the one who believes the car can fly — is trying to put his foot on top of Boehner’s on the accelerator pedal.

Yes, people who cannot do basic arithmetic are in charge here. And they’re throwing a childish tantrum because they can’t get their way.  Only unlike a child who’s threatening to hurt themselves if they don’t get their way, these folks could potentially take us all down.

The facts are that nobody knows for sure what happens if Congressional Republicans don’t raise the debt ceiling by August 3. But it defies imagination to think it will be smooth sailing. It depends on how the Obama adminstration reacts.  There might be ways around it.  A couple of proposals exist. The government could dispute the constitutionality of the debt ceiling law or it could mint some super-large coins (such as billion-dollar coins) that would only be used as Marshall Auerbach has noted:

Or the President could, as we and others have suggested in the past), simply invoke the 14th amendment and refuse to enforce a statute that he believes violates the Constitution.

Professor Scott Fullwiler has suggested an even more creative way around the debt ceiling: Fullwiler notes that Fed is the monopoly supplier of reserve balances, but that the US Constitution bestows upon the US Treasury the authority to mint coins (particularly platinum coins). Future deficit spending by the federal government could thereby continue to be carried out by minting coins and depositing them in the Treasury’s account at the Fed (for more details see here).

Curiously, the President won’t pursue any of these options.

These options would keep financial markets on an even keel but could provoke a constitutional and legal crisis as the Tea Party types would not doubt file endless lawsuits challenging it.  But thinking about these options is largely academic since Obama shows no inclination to exercise these options or to explain why he doesn’t.   Obama shares responsibility because he’s let the Tea Party types and Republicans take this charade this far.

Let’s consider a more likely intermediate case.  As mentioned in another post, to immediately stop all new borrowing and instantly balance the budget, the government has to cut 40% of it’s spending right now.  The federal government accounts for $3.8 trillion of spending in 2011.  GDP is expected to be in the $15 trillion range.  If the government cuts 40% of that $3.8 trillion instantly, that’s a $1.5 trillion cut in spending. Government spending is part of GDP (despite what far right-wing types believe).  So an instant balancing of the budget on Aug 3 means a 10% cut in GDP.  When the economy collapsed in 2008 it was only approximately a 5% drop in GDP.  So the “intermediate” case of default is an instant recession twice as big as the “Great Recession” of 2008.  Apparently the Republicans and Tea Party types loved 2008-09 and the bailouts so much they want to repeat it and double down.

Now what’s the worse case?  Well add into the scenario a financial crisis to dwarf 2008.  See US bonds are AAA rated because there’s no chance of default.  If there’s a default, or even a slight increase in the possibility of a future default, then pension funds, banks, and central banks around the world no longer have safe, interest bearing assets.  Chaos. Pension funds have to sell bonds.  Bond prices drop. Interest rates rise. Banks lose capital as the bonds fall in value. Nobody knows which banks are worst off.  A mess to make 2008 look simple.  And guess what, we’ll be back to bank bailouts only with even more unemployment.

Why can’t we have grown-ups in Washington?  These kinds of scary scenarios should be fictional and in the movies.  It shouldn’t be national policy to deliberately default and crush the economy just to make some political policy victory that you couldn’t win straight up.

 

* racing cars in real life is different.  😉

Tax Cuts and Economic Growth, Once More – the Corporate Tax Version

The issue of tax cuts and economic growth, which I’ve discussed recently here and here, looks like it’s going to be an important topic for some time now judging by this week’s announcement from Paul Ryan, one of the Republicans in the U.S. House of Representatives.  While all the attention in the media has been focused on the proposed changes to Medicare and Medicaid (I’ll get to those soon), that’s not really where the deficit reduction is supposed to come from in their plan.  When you look at the plan and their projections, it’s really a dramatic improvement in the health of the economy and employment that drives their projected budgetary improvement.  And what do they propose will instantly get this slow-growth economy to dramatically improve immediately?  Why tax cuts of course!  I’ll have more on the specifics of the Republican proposal soon, but for now I want to note the experience of our polite neighbors to the north with regard to this issue of tax rate cuts and economic growth.

In Canada’s case, they bought into the rhetoric of “tax rate cuts” will grow the economy ten years ago.  But the Canadians bought the corporate version.  Specifically, the cut corporate tax rates dramatically over the past decade.  The goal was to growt the economy.  This is the exact same strategy that Rick Snyder, Scott Walker and a host of other Republican governors are now trying to implement in different states in the U.S.  So it should be enlightening to see what happened when somebody else did it.  What happened?  Let’s turn to the Globe and Mail today (emphasis is mine):

Canadian companies have added tens of billions of dollars to their stockpiles of cash at a time when tax cuts are supposed to be encouraging them to plow more money into their businesses.

Corporate tax cuts are becoming a major issue in the federal election campaign. The Conservatives, arguing that they are the best custodians of an economy that remains fragile after the recession, say tax cuts are crucial to stimulate job creation and make Canada more competitive on the global stage.

But an analysis of Statistics Canada figures by The Globe and Mail reveals that the rate of investment in machinery and equipment has declined in lockstep with falling corporate tax rates over the past decade. At the same time, the analysis shows, businesses have added $83-billion to their cash reserves since the onset of the recession in 2008.

Infographic

In other words, the corporate tax rates did not increase corporate spending on investment.  In fact, the corporate tax rates actually coincided with lower corporate spending on investment.  It’s corporate spending on investment that is what generates and contributes to GDP growth.  So lower corporate tax rates simply functioned to increase profits but those profits are sterile.  They became piles of cash.  Cash that might be used to buy another existing company (and then layoff people) or just allowed to sit idly in the money and bond markets earning more interest.  What lower corporate tax rates do not do is create jobs.

So back to an earlier discussion – does this mean we should stop saying in principles classes that “tax cuts are stimulus”?  No.  It means we have to be more careful in what we say.  A better and more true statement is that:

Tax cuts for middle- and low-income individuals that result in more consumer spending, and tax cuts that are accompanied by deficits (meaning the tax cut isn’t offset by lowered govt spending) will stimulate an economy and grow jobs while tax rate cuts for corporations and high-income individuals won’t.

Unfortunately that’s 50 words long.  That’s way beyond the attention span or understanding of most politicians and media commentators.