August 8, 2011

STANDARD & POOR’S decision to downgrade the long-term credit rating of the United States should have been accompanied by a modest mea culpa.

S&P, after all, played a major role in stoking the 2008 meltdown that continues to haunt the global economy. Rather than warn of impending danger, S&P encouraged irresponsible investment by giving its blessing to real-estate-backed instruments that turned out to be junk. Institutions and individual investors, lured by the prospect of huge returns on what were deemed ultra-safe investments, soon found themselves stuck with toxic assets. Credit markets froze, the economy shrank and thousands of jobs disappeared.

S&P, as it is quick to point out, was not alone in misjudging the market, but it was alone on Friday when it became the first credit agency to punch down the country’s long-term credit rating, from the platinum AAA to AA-plus.

“No matter what some agency may say, we’ve always been and will be a Triple-A country,” President Obama said Monday in a speech meant to quiet turbulent markets. It didn’t work on the stock market: The Dow Jones industrial average fell an astounding 635 points, its biggest drop since the dark days of 2008.

There’s a reason the president’s words did not allay market fears: For all of its faults, S&P was right about its assessment of the problems that underlie the U.S. economy. Government expenditures are too high; revenue remains untenably low; and the rancorous political environment that brought the country to the brink of default last week casts doubt on the willingness of its leaders to correct the imbalance. Fairly or not, the turmoil in the European markets also continues to fuel the crisis of confidence in the equities market here, even as investors from all corners paradoxically flock to U.S. Treasurys — as well as gold — for safe haven.

The long-term impact of the downgrade is not yet clear. Yesterday’s market reaction suggested that interest rates could be unaffected as investors shrug off the S&P warning. But over time rates for everything from muncipal bonds to mortgages could be at risk — especially if Congress fails to take more decisive action on the debt. In a few months, the “super-committee” created under the debt ceiling agreement will be tasked with finding another $1.5 trillion to cut from the budget. Failure is not an acceptable outcome, but even success in this short-term goal will not be adequate. More cuts — S&P puts the total savings figure at $4 trillion — must be found, lest the country risk a further downgrade.

Adjustments to entitlement programs, including Medicare and Social Security, must be a part of the equation, even in the face of Democratic opposition. New revenue — yes, taxes — must be considered despite Republican vows to resist. The political and market turmoil of the past few weeks will be worth it only if the country’s leaders meet the challenge of coming up with full-fledged solutions.