On debt ratings and recession

Congress and the President come up with a deal to extend the debt ceiling.  They agree to cut $2.5 trillion from deficits for the next 10 years.  And yet Standard & Poors decided last Friday to downgrade US debt from AAA to AA+.  My reaction (which ironically is about the same as Paul Krugman's):

1. Remember that S&P was rating bonds based on subprime mortgages AAA in 2008.  
2. The US Treasury found a $2 trillion error in S&P's initial calculations Friday afternoon before the downgrading was announced.  This raises serious questions about whether the downgrade was based on technical analysis of default probabilities or was made for other reasons. 
3. As the stock market slides for another day, it seems investors cannot get enough US Treasury bonds (yield for two year bonds is now down to 0.2%).  The downgrade sure has not scared them. 
4. No other country is listed at AA+.  AAA countries now include Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey (I did not know these islands in the British channel were a country), Hong Kong, Liechtenstein, Luxembourg, Netherlands, New Zealand, Norway, Singapore, Sweden, Switzerland and the United Kingdom.  Spain, which is a genuine risk for sovereign debt default, is AA. 

Meanwhile, Dr. Doom (aka Nouriel Roubini of NYU's Stern School) thinks a double-dip recession is becoming more likely in an article in yesterday's FT.  He points out that there is not much that fiscal or monetary policy can do now, and that more attention should be paid to dealing directly with household debt, especially underwater mortgages.  

One way for states and cities to cut budget deficits

Sell assets.  WSJ writes about various state and local governments who have decided to convert various properties into revenue streams.  You name it: office buildings, airports, parking meters, toll roads, and zoos have all been auctioned off to the highest bidder. 

What does this mean for economic well-being?  The good news for consumers is that private owners are likely to run these assets more efficiently than state or local governments.  The not-so-good news is the substitution of private for public monopoly could mean higher prices and less output.  Also, asset sales provide one time relief -- you can only sell I-95 off once.  Unless state and local governments take other steps to bring their income in line with their expenditures, these sales only postpone the ultimate day of reckoning. 

France and Spain face the music

Traditionally the US economy has been market-oriented than that of the European Union and the government has played a less active role.  Regardless of whether you agree or disagree with the policy changes that have taken place since President Obama took office, no one should act surprised that the US government has been more activist. 

But here is a surprise: today's NYT reports that both France and Spain are taking steps to better align their economies with market forces.  France is going to raise its minimum retirement age from 60 to 62.  This will help reduce future budget deficits, along with an increase in the highest tax bracket from 40 to 41 percent.  It also recognizes the simple fact that people are living longer, more productive lives. 

Spain is changing its mandatory severance pay from 45 days for each year worked at its former company to 33 days.  Many companies have shifted to temporary one year contracts that are exempt from this regulation, so the intended effect is to encourage permanent job creation. 

The Times calls these steps austerity measures.  I would call them coming to grips with economic reality.  When can we expect the US to face the music on Social Security and the deficit?  

State pensions start to face reality

Research by economists, accountants and actuaries (including by NC State colleague Bob Clark) shows that most state and local governments have pension obligations that far exceed projected assets.  The options are not attractive: raise taxes, cut services, or cut promises of future benefits.  Today's WSJ reports that Colorado and Minnesota are starting to take modest but painful steps to reduce future benefits.  Colorado had been providing an annual automatic "cost-of-living" increase of 3.5 percent, whereas Minnesota had been providing 2.5 percent.  Under laws passed in each state, Colorado increases will be capped to 2 percent and Minnesota increases will be limited to 1 to 2 percent. 

The article quotes some state employees who retired counting on these future increases and notes (no surprise here) that lawsuits are being filed.   The article says nothing about retirees from the private sector who typically receive no pension benefit increase at all.  It also says nothing about current and future state employees who will undoubtedly have to settle for even smaller pensions.  How will we decide to balance the obligations to retirees with other commitments made by state and local governments?  This will be an interesting story to watch in the years ahead. 

Today Greece, tomorrow the US?

Over the weekend the European Union (EU), the IMF, the Fed and other parties put together a trillion dollar line of credit for EU members who are at risk of defaulting on their debt.  The stock market reacted favorably on Monday, reversing most of last week's losses.  Today NYT writer David Leonhardt draws comparisons between the Greek economic situation with that here in the US.  At an abstract, qualitative level the two situations are similar: both countries are living beyond their means and are borrowing from foreigners to make up the difference.  Fortunately for the US, the scale of the problem here is more manageable than in Greece.  Nonetheless we face unpleasant choices; we cannot have more government programs and spending (as preferred by Democrats) AND more tax cuts (as preferred by Republicans).  Who elected these politicians anyway?  Oh, we did. 

Greece is the word

Paul Krugman's NYT column today does a great job explaining the sources of the Greek economic crises and pointing out the limited options available to deal with it.  The essence of the problem is that even though Greece's economic issues may not be as severe as those facing some some states in the US, states such as California can rely on federal programs such as Social Security, grants and stimulus packages whereas there is no European central government with taxing and spending authority to help Greece out. Krugman believes that Greece will ultimately have to go off the Euro and issue a new devalued currency that will reduce real wages and make Greek exports economically competitive.  A debt default a la Argentina in 2001 is also in the cards.  Other European governments (Portugal, Spain, Ireland in particular) could be in the same boat.  Krugman seems to think this will not be as disruptive as the fall of Lehman Brothers; I hope he is right.

Republican supports new tax

There's a man-bites-dog headline for you. Today's Tom Friedman NYT column features an interview with SC GOP Sen. Lindsey Graham who apparently supports a carbon tax. This tax would create incentives for energy conservation and pollution abatement, as well as making us less dependent on foreign oil. Helps with global warming too, if you still believe that. More jobs, cleaner air, and a thumb in the eye to petroleum-supported autocracies (Russia, Venezuela, Iran) who have not been playing nice in world affairs -- what's not to like? One also could use the proceeds of such a tax to reduce the federal budget deficit, or make it budget-neutral by making off-setting tax cuts. In economic terms this would be far superior to the cap-and-trade bill passed by the House last year. Stay tuned, this could get interesting.

Why Greece matters

Good column by Washington Post economist Robert Samuelson about the economic situation in Greece and how it is affecting the euro. In a nutshell if Greece had its own currency it would be falling in value and interest rates would be rising reflecting the growing risk that Greece will default on bonds that must be paid off this spring. Other EU countries have to decide whether to bailout the Greeks and thus stabilize the euro versus cutting them loose to revert to their own currency. Greece's situation is not unique to the EU; it is shared by Portugal, Ireland, Italy and Spain (the five countries now have the unwanted acronym of PIIGS). States such as California and Michigan may very well be creating a similar problem here in the US in the very near term.