Scott Spiegel

Last week Moody’s Investors Service threatened to downgrade the U.S.’s Aaa credit rating if the nation fails to raise its $14.3 trillion debt ceiling before August 2.  On Monday the agency counseled the U.S. to scrap its debt ceiling altogether.

Standard & Poors (S&P) and Fitch, the other two major credit rating agencies, recently echoed Moody’s warning.

Democrats pounced on Moody’s pronouncement as ammunition in Congressional budget talks, citing Moody’s as an unimpeachable source on what to do with our debt ceiling.

Why is anyone listening to what Moody’s has to say about the economy?

Moody’s, S&P, and Fitch are the same credit rating agencies that helped precipitate the subprime lending crisis of 2008.  These bureaus continued to give large financial institutions their highest ratings until the last minute, despite the flimsy cores of these firms’ collateralized debt obligations and mortgage-backed securities.  Moody’s and company thought the Democrats’ Community Reinvestment Act was a splendid idea, with the result that millions of investors lost billions of dollars and the international market collapsed.

Credit rating agencies work to offer valid, objective, neutral assessments of companies and sovereign states’ creditworthiness by systematically reducing outside influence and making their ratings as independently as possible.  However, if they hold invalid ideas about how governmental policy and economic principles interact, their predictions will be as shoddy as Paul Krugman’s.

Ratings agencies are subject to the same biases that businessmen, Wall Street investors, banks, and homeowners are.  Moody’s eight-member Board of Directors, for example, includes the following advisors: one director of the Federal Reserve Bank of Dallas, one member of The Federal Reserve Bank of New York Financial Advisory Roundtable, one director of Freddie Mac, and one director of the Dutch National Bank.  So 50% of Moody’s Board of Directors includes members who are heavily involved in central banking.

As one disillusioned former Moody’s VP lamented at Congressional hearings on the subprime lending crisis, “I had this somewhat naive idea when I joined Moody’s that it was a particular quality Moody’s was offering, and that was something that the company was going to seek to defend over time.”  Not quite.

In contrast to Moody’s and spend-happy Democrats, Republicans have been insisting that the nation has more than enough revenue to cover interest on our debt, military pay, Social Security, and other high-priority items for months without raising our debt ceiling.  There is literally no risk of the U.S. Treasury defaulting on our debt, unless petulant Democrats sabotage the process.

Because Moody’s admits it will downgrade the U.S. only if a default happens, not if we fail to raise our debt ceiling, there should be no need for a downgrade.  The U.S. failed to raise its debt ceiling on nine occasions in the past, from 1973 to 2007, with no concomitant default or credit rating downgrade.

There hasn’t been a looming catastrophe this overblown since Y2K.

The debt ceiling scenario is analogous to a hypothetical credit card holder who gets to arbitrarily raise his credit limit as often as he wants.  On August 2, the cardholder runs out of money to borrow.  He has more than enough income to pay the interest on his card and meet his basic living expenses.  Republicans are arguing that because he’s raised his limit so many times and is spiraling into a sinkhole of debt, he should cut up his card, rework his budget, and pay the card off.  Democrats are arguing that he should raise his credit limit again and charge the interest payments to his card, in case the credit card company is worried that he’ll fail to make them—as he always has before—and blow the money on a trip to Bermuda.

Can someone explain to me how the Democrats’ plan is more financially responsible and reassuring to bondholders?

Moody’s also argues that because the U.S. is one of the few nations that self-imposes a debt ceiling, yet has continually voted to raise it, this creates periodic uncertainty regarding whether the U.S. can service its debt; hence, the ceiling should be eliminated.

A debt ceiling is certainly not an essential aspect of governing a sovereign state.  But in this era of trillion-dollar deficits, doesn’t it serve the purpose of holding our politicians in check and sending the populace periodic wake-up alarms?  Shouldn’t a debt ceiling, however imperfectly administered, be recognized as a good-faith attempt to control a nation’s debt?

True, the debt limit has been raised many times in the past.  But in a limited government whose constitution is suffused with checks and balances and limits on rule, is it so foolish to have one at all?

If debt limits are such a poor idea, why do credit card companies impose them on cardholders?

The problem isn’t that debt limits are bad, as Moody’s implies, but that the U.S. government has been borrowing so much for so long that it thinks it has none.

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Related articles

• Moody’s Warns Back Up Debt Ceiling Plan Won’t Prevent Downgrade (businessinsider.com)
• Moody’s eyes possible credit downgrade on 5 states (seattletimes.nwsource.com)
• Debt ceiling impasse imperils states’ credit ratings (money.cnn.com)
• Moody’s Suggests Eliminating Debt Ceiling (politicalwire.com)
• Third Bond Rating Firm Threatens Credit Downgrade If Debt Ceiling Isn’t Raised (outsidethebeltway.com)

Critics of Federal Reserve Chairman Ben Bernanke’s performance in his first term blame him for failing to recognize the threat of the looming subprime lending crisis; his supporters laud the aggressive policies he enacted in response to the crisis.

I fault him for both.

Before the crisis, Bernanke helped Fannie Mae and Freddie Mac executives cover up their scheme to hide trillions of dollars in junk mortgages and give themselves enormous bonuses.  In the process, he failed to address the growing housing bubble that precipitated the financial crisis.

His solution was worse.  Having learned the wrong lesson from the Great Depression—that the government prolonged it by not intervening more, rather than intervening too much—Bernanke radically expanded government’s power and “reinvented the Fed,” as Time magazine put it mildly in their recent cover story on Bernanke.

Time glowingly continued: “[H]e conjured up trillions of new dollars and blasted them into the economy; engineered massive public rescues of failing private companies… lent to mutual funds, hedge funds, foreign banks, investment banks, manufacturers, insurers and other borrowers who had never dreamed of receiving Fed cash… revolutionized housing finance with a breathtaking shopping spree for mortgage bonds; blew up the Fed’s balance sheet to three times its previous size; and generally transformed the staid arena of central banking into a stage for desperate improvisation.”

“Conjured up,” “blasted,” “engineered,” “revolutionized,” “breathtaking,” “shopping spree,” “blew up,” “desperate improvisation”—somehow these don’t sound like particularly reassuring terms for investors in the world’s largest financial system.

Bernanke isn’t finished.  The Federal Reserve has been buying up Fannie and Freddie securities to try to keep mortgage rates artificially low and stimulate the housing market.  The program is set to end in March, but Bernanke is toying with the idea of propping up the housing industry indefinitely.  Sound familiar?

The question is whether the Senate will reconfirm Bernanke for another four-year term before his first term expires on January 31.

Dumb arguments for keeping Bernanke abound:

•    The Financial Times of London reports, “Economists warned that a rejection of Mr Bernanke could be seen as a threat to the central bank’s independence.  US Treasury yields were little changed but stocks fell more than 2 per cent” due to uncertainty regarding reconfirmation.

Come on—it’s at least as plausible that stocks plummeted last week because of Obama’s announcement that he was going to impose a new tax on banks to subsidize the Troubled Assets Relief Program (TARP).  (Especially given that the Dow Jones Industrial Average slipped 219 points while Obama was still giving his speech.)

After Bernanke’s prospects improved over the weekend, Obama’s boosters at the Associated Press helpfully divined the trend in the stock market for us: “Amid the news, the Dow Jones industrial average rose 24 points.”  Well, the Dow was down 3 points on Tuesday—I think this means Bernanke’s chances are dimming.  What say ye, Associated Oracle?

•    Mohamed El-Erian, CEO of bond investor Pimco, declared, “A No vote on Bernanke would be viewed by markets as adding yet another uncertainty in an already fluid economic and policy environment.”

Give me a break: Ben Bernanke-Tim Geithner-Larry Summers form the very Axis of Uncertainty.  The Obama administration has demonstrated that it is capable of deciding, in any given week and depending on its poll numbers, to announce any manner of blanket economic policy to try to shore up its popularity.  This is exactly what causes uncertainty in the market: whimsical manipulations from disconnected puppet-masters on high.  Sowing a little uncertainty about whether King Caprice’s minions will remain in office is the surest prescription I know of for assuaging the market.

•    Obama’s team “saved” the economy, so it’s best to keep the same leadership in place.

Obama’s team didn’t save anything—it wasted a trillion dollars and slowed down the real recovery.  Obama claimed that unemployment would reach 8.0% if we didn’t pass his stimulus bill last spring.  We did, and unemployment is at 10.0% and projected to increase.  The last people who should still be in charge of our monetary policy are the people who helped Obama implement his disastrous recovery strategy.

•    Chris Dodd, the Senate banking committee’s chairman, announced that booting Bernanke would hurl our financial system into a “tailspin.”

Chris Dodd certainly knows something about sending the economy into a tailspin.  Given his role in the subprime lending crisis, I say his vote on any financial matter from now until his retirement next January ought to automatically count as a vote for the opposite of whatever side he’s on.

•    Dick Durbin, Senate Majority Whip, pointed out that conditions that led to the financial crisis were in place before Bernanke took office.

Yes, and if Noah had deliberately drilled a hole in the bottom of his ark, I think he could credibly claim that conditions that led to the Great Flood were in place before his time at sea.  But that doesn’t mean he would bear no responsibility for having made things worse.

Paul Krugman, whom I never thought I’d quote (except mockingly), recently wrote, “Before the crisis struck, Mr. Bernanke was very much a conventional, mainstream Fed official, sharing fully in the institution’s complacency.  Worse, after the acute phase of the crisis ended he slipped right back into that mainstream.”  Granted, Krugman is only partly talking about Bernanke’s failure to head off the imminent lending crisis.  He’s also talking about Bernanke’s failure to push for cumbersome bank regulations and inflate the currency, goals Krugman seems to think worthwhile (we are talking about a New York Times columnist, here); but the general characterization still applies.

Krugman continues, “During the run-up to the crisis, as financial abuses proliferated, the Fed did nothing.  In particular, it ignored warnings about subprime lending…  Mr. Bernanke didn’t acknowledge that failure, didn’t explain why it happened, and gave no reason to believe that the Fed would behave differently in the future.”

I’m mystified as to why so many in Congress are reluctant to sack Bernanke for poor performance.  Perhaps it’s because they fear it will remind their constituents that they may apply the same standard to their elected officials.

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