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Saturday, August 6, 2011

S&P Downgrades U.S. Debt

As you have probably heard by now, Standard and Poor's has downgraded U.S. debt one notch from AAA to AA+ with a negative outlook. This will be bad for the country because it will likely increase borrowing costs; in turn, this is bad for the middle class because it increases the deflationary pressures on the government.

The go-to analysis of the rating agencies in political science is the work of Timothy Sinclair of the University of Warwick, especially his book The New Masters of Capital (Cornell University Press, 2005). (Disclosure: he and I co-edited Structure and Agency in International Capital Mobility, Palgrave, 2001, and have known each other for over 15 years.)

Sinclair argues that credit rating has become a form of "private regulation," which governments have had to pay increasing attention to since the rapid internationalization of financial markets. This regulatory power is based on the agencies' perceived expertise, which comes into occasional question after spectacular failures like Enron (analyzed in his book) or the 2008 financial meltdown but persists after those analytical disasters.

As Sinclair has long argued, the role of the agencies is not neutral politically. They have pushed for market liberalization in Latin America, put enormous pressure on city governments like those of New York, and shown favor to financial orthodoxy generally. We have seen this in S&P's recent statements that a $4 trillion package of debt reduction was necessary to prevent a downgrade; and S&P has now followed through on its implied threat.

As Paul Krugman has discussed, most of the reasoning behind the downgrade stems from the ungovernability of the United States due to the intransigence of Congressional Republicans on increased tax revenue. He argues that after the failure of S&P on mortgage derivatives, it has no right to pass judgment on the US. However, Sinclair's analysis of the credit raters' failures on Enron, WorldCom, etc., suggests that S&P's power has probably remained intact despite its failure on mortgages.

Krugman is right to challenge the legitimacy of S&P's decision; this is an enormously important moment in the battle against deflationary policies being undertaken during a jobs crisis. Indeed, the agency has complained about the country's "ungovernability," while at the same time rewarding the very people who are making it ungovernable with a decision that ultimately promotes their preferred policies. We cannot afford for this to stand.

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