S&P Downgrade of U.S.: What Nerve!

S&P Downgrade of U.S.: What Nerve!

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Here are five quick thoughts on S&P's downgrade of U.S. debt.

1) Let's get this out of the way first. What nerve. S&P is one of the credit rating firms that just four years ago were giving risky mortgage securities absurdly inflated ratings that they knew were bogus, and which helped bring the nation's financial system to its knees. See this infamous instant message exchange between two unidentified S&P officials about a deal the firm was rating:

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.

2) That said, of course S&P is right -- at least in its analysis of the current fecklessness of the political system and its inability to do what's necessary. The writing in S&P's press release is clumsy, but the message couldn't be more correct. Here's a paraphrase: The recent standoff over the debt limit had to lower any rational observer's already low opinion of Washington's ability to compromise on a real plan to stabilize and reduce the national debt. The "deal" Congress and the president agreed to was pathetically inadequate. Both parties are so destructively dug in that there's little likelihood that Washington will agree to change entitlements or raise taxes enough to produce an effective package -- and both are required. Time is running out -- the national debt is already dangerously high, and any realistic projection has it going higher. The Bush tax cuts won't be allowed to expire, and even if President Obama managed to make them go away for the wealthy, that wouldn't produce nearly enough revenue to make a difference.

All this is painfully obvious. But how refreshing to hear S&P say it.

3) Now wait a minute. The political gridlock S&P is worried about is nothing new. It always takes Washington a long time to do the right thing. It took 18 years to go from President Reagan's absurd 1980 pledge to balance the budget while cutting taxes and raising defense spending to four years of balanced budgets beginning in 1998. Along the way there were three agonizingly difficult budget deals -- Social Security in 1983, President Bush's deal in 1990 (when he ate the no-new-taxes pledge) and President Clinton's deficit-reduction deal in 1993, which got zero Republican votes and helped elect a GOP Congress in 1994. Each of those deals was an indispensable brick in the wall. It took the system almost two decades and huge political agony to get where it needed to go.

Correct. But the difference now is that we don't have 18 years. From 1980 to 1998, the U.S. public debt ranged between 26% of GDP and 49% of GDP, well within historical norms. Now, S&P projects it will hit 74% of GDP by the end of this year, and 85% to 101% of GDP by 2021.  (The Treasury Department disclosed this week that -- for the first time since 1946 --  the gross federal debt, including all borrowing,  is greater than the overall size of the U.S. economy. . 

4) The best outcome -- politically -- is that this report will empower rational members of both parties to embrace a $4 trillion "grand bargain" that includes higher revenues and changes to Medicare, Medicaid and Social Security -- all necessary to produce a package big enough to get the debt under control. The worst political outcome is that neither party will get the message and jihadis on both sides will dig their parties in further.

5) The outcome in the real, non-political world is unknown and frightening. We're in uncharted territory. The markets will look to Washington for a signal. This feels like a bad time for Congress to be on vacation, but it lets President Obama -- who has been honing his role as Washington's most reasonable man -- set the tone. 

Hager is a member of  the editorial board of USA Today