Debt Downgrade: Obvious Symptom of Bigger Problems

The Standard & Poors (S&P) rating agency downgraded US debt from AAA to AA+ with a negative bias on August 5th 2011. Prior to Aug. 5th, 2011, the US had enjoyed its AAA rating for almost a century.  This downgrade was forecasted, and it should have been expected. More importantly, the downgrade doesn’t matter in and of itself. It is a symptom of far greater problems.

S&P based their decision on the “difficulties in bridging the gulf between political parties.” Without a hint of irony, each party blamed the other shortly after the announcement was made and avoided taking any responsibility for this unprecedented move on the part of S&P.

The huge US deficit, debt ceiling and potential for a ratings downgrade were issues well known to our political leaders. It is impossible to believe any of them were surprised by S&Ps action.  S&P and the other rating agencies were left with egg on their faces for the dubious quality of their ratings of real estate debt instruments in the first decade of this century. They needed to re-build credibility, so they drew a line in the sand. Then our political leaders stepped over it as if they didn’t even see it. S&P spelled out exactly what they would do. Now they have followed through on that promise. The politicians didn’t listen – plain and simple.

This brings us to the first problem we face: politics by entrenched party edict. Clothed in their party banners, politicians are holding our nation hostage.  I think it is time that the American public adopts the behavior of Wyatt Earp in the 1993 western, “Tombstone.”  In the movie, Wyatt Earp (played by Kurt Russell) is infuriated with a Gang called ‘The Cowboys,’ who are terrorizing Tombstone in their trademark red sashes.  In one memorable scene, Earp stands screaming into the wind, “From now on I see a red sash, I kill the man wearing it. So run you cur. And tell the other curs the law is coming. You tell ’em I’m coming! And Hell’s coming with me you hear! Hell’s coming with me!”

I am not advocating we murder any members of congress or start shooting senators, but we should exercise the political equivalent and vote them out of office. We won’t, though, because we are just as guilty. Therein lies our second problem: we each beg and plead for a piece of the national pie.  Some of us want more food and shelter programs, and some think we need more defense spending. Some of us seek better re-entry programs for criminals, and some would like more social programs. Some of us demand more healthcare benefits or greater benefits for public employees. Every single one of us has reached into Uncle Sam’s cupboard.  Unfortunately, 1/3 of everything we have pulled out of that cupboard in the last decade was borrowed from someone else.  S&P is merely pointing out the fact that the cupboard is now bare.

S&P’s decision to downgrade US debt does matter – primarily as a warning sign to get our fiscal house in order. Fortunately, this downgrade of the U.S.’s credit rating isn’t yet as serious as when an individual like you or me receives a “bad credit rating” from a consumer credit rating agency like Experian or Transunion. These consumer credit rating agencies gather information about all the debt an individual owes and report if they are current or behind in payments.  Credit card companies, mortgage bankers, and other businesses report your payment history to these agencies. That way, if one of them wants to lend you money, they can evaluate whether you are a good or bad credit risk.

For example, my wife and I do the majority of our spending on our credit cards, because we love those airline miles.  We pay that borrowing off every month.  We borrowed to buy our house and we borrowed to remodel our house.  I have borrowed to buy a new car, although I count that among my momentary lacks of discipline and financial mistakes.  If we were to rack up lots of debts – whether or not we made payments – our credit rating would suffer.  If our credit rating suffers, our cost of borrowing will go up.  But it wouldn’t be the credit rating that causes us to pay higher interest. It would be our own lack of discipline.

The same is true for a sovereign nation.  There is a limit to what the market will lend us as a nation.  The more debt the U.S. has, the more money we will have to commit to paying the interest on that debt.  The more future liabilities we have, the less money we will have available to pay that debt. Our politicians have indulged our constant demands for immediate gratification while ignoring their responsibilities to maintain fiscal discipline.  They have demonstrated that they either believe they are above the need for market discipline or that they do not understand the market.  They acted as if they and their constituents could have all the pie they wanted and cut deals for each other that increased the long-term financial risk to our country.

Either our politicians start demonstrating fiscal responsibility, or we should elect representatives who are willing make the tough choices.  As I see it, our roles are easy to define:

The role of a politician is:

  1. To keep the national pocket book
  2. Recognize our limited resources
  3. Make the tough choices regarding the application of those resources

Our role as a voting public is:

  1. Review our elected representatives’ choices
  2. Keep them or vote them out

We and the politicians must share the blame for the current debacle. The good news is, since we are part of the problem, we can also be part of the solution come next November.

Jonathan K. DeYoe, CPWA

Member FINRA/SIPC and a Registered Investment Advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.