Five thoughts on the potential S&P downgrade

Standard & Poor’s announced Friday night that it downgraded the U.S. government’s AAA credit rating. The administration reportedly has been pressuring the credit rating agency to reconsider.

Tyler Cowen has six useful thoughts here. I’d add a few more:

1) S&P is downgrading their estimation of our political system, not our actual ability to pay our debts. Indeed, the past 36 hours offered a stunning demonstration of the market’s faith in our ability to pay our debts. The panic sent investors rushing to buy Treasuries, sending yields on 10-year Treasuries to 2.4 percent -- that’s almost nothing -- and demonstrating that American debt is still considered the safest bet in the world. That vote of confidence under real world conditions is far more important than anything S&P says.

2) Of course S&P is downgrading our political system. Did you see the nonsense we pulled over the past few months? The Republican Party took the country to the brink of default, and for what? A smaller and less certain deficit-reduction deal than they could have gotten if they had been willing to compromise with the Democrats. And then Senate Minority Leader Mitch McConnell said these default-driven deals would be the norm around Washington from now on. Why shouldn’t S&P downgrade our debt?

3) This is very odd timing from S&P. The markets are very fragile right now. But you can take that both ways: It suggests that S&P either wanted to make a huge splash with their downgrade, or, because they’re doing it at a time when investors have precisely zero other options they like and are thus likely to continue to hold Treasuries -- see point #1 -- that they don’t want to make too much of a splash.

4) The S&P might call out Republicans for refusing to accept any deal that increases taxes. This could be important. I’m often told that there are a large number of Senate Republicans who would like to pass a grand bargain even if it includes revenues. Note, for instance, the positive reaction many Senate Republicans had to the Gang of Six plan, which raised $2 trillion in revenues. If this is true, then the S&P report will give these Republicans the excuse they have needed to strike a compromise.

5) It is entirely possible that a downgrade will not show up in Treasury yields, but will nevertheless harm the economy by leading to a downgrade of various types of debt linked to federal payments (state and municipal debt, certain forms of corporate debt, etc.) and contributing to the general climate of “we’re not out of the woods yet.” There’s no particular reason a corporation or entrepreneur should have been feeling confident about our prospects for recovery last month, but there’s absolutely no chance they’re feeling confident about our prospects this week.

Related: Megan McArdle has more commentary. There’s also this report from the centrist think tank Third Way, though I think the scenario is describes is more alarmist than this particular situation warrants. Here’s my interview with the S&P director responsible for the downgrade, if it happens.