A Pox on Both Houses

07/26/2011 12:30 pm EST

Focus: MARKETS

The wrangling over the debt ceiling and the calamitous effects it’s already having should be enough to make people long for a third party in Washington, writes Jim Fink of InvestingDaily.

The stock market was up strongly last week on a second bailout plan for Greece, as well as investor optimism that the US debt ceiling will be raised, at least temporarily.

Europe’s new plan for Greece appears to take a long-term approach and is not a stopgap measure. Kudos to Europe.

Unfortunately, I can’t say the same thing about the United States, which amazes me since the European Union is a hodge-podge of independent states that constantly fight with each other, compared to an allegedly “unified” United States. The American people are no longer disappointed with the US political process—they are actually disgusted by it.

What is wrong with the US? The ideological polarization in this country is staggering, and jeopardizes our long-term future.

Despite talk about a Senate “Gang of Six” plan to reduce the government budget deficit by $3.7 trillion over ten years, this plan is a mere outline. Nobody thinks it will be finalized in legislative form by the August 2 deadline.

The most likely scenario is a temporary, six-month raise of the debt ceiling with no long-term plan. As Senate Budget Committee Chairman Kent Conrad said last week:

You know, I’ve always believed that there will be first a shorter-term extension. I would prefer one that’s perhaps six months in duration so that you start the process—you begin with a down payment, then you have time for the committees of Congress to come back with a floor package. That’s my own view of how this should work, and I think it’s more in tune with the realities of the magnitude of the task.

Start the process? I can’t believe that President Obama and Congress haven’t been working on a serious and long-term debt-reduction plan for months already.

This is an outrage.

The US Debt Commission issued its report on the disastrous state of the country’s finances…last December! President Obama completely ignored the report, and Congress appears to have done the same.

What in heaven’s name have the President and Congress been doing all this time? Nothing is the answer, other than making useless and divisive ideological pronouncements on the left (no entitlement spending cuts) and right (no tax increases) that get us nowhere.

Of course, it is “stupid and naïve” to think that the solution will not require some of both, as Oklahoma Senator Tom Coburn said recently.

I think the powers-that-be behind the stock market are being too sanguine about a temporary debt-ceiling extension. Sure, the prospect of an immediate default will be eliminated, but the country’s long-term problems are just being kicked down the road—again.

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Standard & Poor’s issued an important warning last week that may only now be getting attention from the stock market. The credit-rating agency warned that there is a 50-50 chance it will downgrade the US credit rating to double-A as early as August, even if a temporary debt ceiling extension occurs!

The key is whether the US government provides a “credible” plan for long-term deficit reduction. If such a plan is not forthcoming by August 2—which appears highly unlikely—S&P is prepared to downgrade US sovereign debt.

Over the past year, Standard and Poor’s has grown increasingly pessimistic about the ability of Washington to solve the US debt burden, even though the objective financial statistics haven’t changed much:

  • October 2010: “We are keeping the rating at ‘AAA,’ with a stable outlook.”
  • April 2011: “We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013.” Credit outlook changed from stable to negative.
  • July 14, 2011: “We may lower the long-term rating on the US by one or more notches into the ’AA’ category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising US government debt burden and are not likely to achieve one in the foreseeable future.” Placed on credit watch with negative implications.
  • July 21, 2011: “If an agreement is reached to raise the debt ceiling but nothing meaningful is done in terms of deficit reduction, the US would likely have its rating cut to the AA category.

Although the July 21 S&P warning sounds very similar to the one made on July 14, I sense that the latter warning ups the ante further. S&P will no longer be satisfied with a credible deficit-reduction deal in the “foreseeable future,” but will require a deal by August 2. No excuses.

I’m getting ready for the unthinkable: the downgrading of US sovereign debt. If it happens, I agree with Boston University economics professor Laurence Kotlikoff that the American people will be so disgusted with the “dangerous extremists” in both the Democratic and Republican parties that a third party will emerge.

It can’t come soon enough.

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