SCORCHING THE FINANCIAL EARTH

Last November 22, my posting was entitled "GOP: Putting the Torch to Everything." The thought was inspired by economist Paul Krugman's inclusion of the GOP in his "Axis of Depression" which included China and Germany because of their opposition to the Federal Reserve plan to purchase $600 billion in government bonds to help drive down interest rates and contribute to economic growth. The need to use monetary policy came because fiscal policy, meaning at the time more federal spending, was blocked in Congress by the GOP backed by the obstructionist tea party (TP) and its fellow traveling fiscal hawks on the right right wing of the GOP.

With the debt ceiling legislation passed with its short term, remedy-light promises for cutting federal spending, and with Congress on vacation where it could do no further damage, it seemed like a time for a breather from the political angst rippling out of Washington everyday. Ah, for the good old days of just two weeks ago. Like the Cold War of yesteryear, just two weeks ago we knew who the enemy was and could try to protect ourselves, emphasis on "try".

But then, out of the cosmos came the credit rating agencies, particularly Standard & Poor (S&P) to gain immediate membership and perhaps leadership in Krugman's Axis of Depression. The three major credit agencies, S&P, Moody and Fitch, had been giving warning about downgrading the country's AAA credit rating because of the fiscal ill-health of the federal government. But there were few who expected the magnitude of the negative impact on the financial world when S&P lowered the U.S. credit rating from AAA to AA+ last Friday. Within two trading days on Wall Street, the Dow index dropped more than 1,100 points, bringing back analyst comparison with the debacle of October 2008 when the fall of Lehman Brothers triggered a Wall Street collapse and the Great Recession which still seems to be with us. In all fairness to S&P it should be noted that there were economic indicators and the fiscal troubles in Europe which contributed to the huge Dow decline.

Aside from the immediate negative impact in financial markets, the really troubling aspect of the S&P downgrade is that that agency brushed aside the fact that its analysis was based, at least in part, on some faulty data. S&P chose to give emphasis to subjective factors, meaning its view of Washington politics and the inability of the players there to deal effectively with the country's fiscal problems, as the primary reason for the credit downgrade. And if that resort to subject analysis isn't enough, there is also the troubling fact that S&P and other rating agencies were among the villains who brought about the collapse of the housing market by overrating mortgage-backed bond issues which were huckstered to investors. So how reliable are they in judging the fiscal health of nations? (See previous post)

Not content with lowering the U.S. credit rating, S&P then proceeded to downgrade the ratings of financially troubled Fannie Mae and Freddie Mac whose holdings of untold numbers of bad mortgages had forced them to keep coming back to the government for bailout money. Those downgrades were overdue. At the same time, S&P lowered the ratings on some Israeli bonds backed by the U.S. government.

Still not finished, on Monday S&P also lowered the ratings on five large insurance companies from AAA to AA+ and warned that further downgrades may be ahead. On the same day it lowered the outlook on five other firms from stable to negative, including Warren Buffet's Berkshire Hathaway. Not content with all of that, S&P also lowered the ratings on some other firms who support credit by loaning to other banks.

And there may be more trouble ahead at the state and local levels. Even before the debt ceiling agreement in Congress, the Moody rating firm warned that at least five states are in trouble because of high levels of reliance on federal funds and the high number of federal employees in the state. If these states are downgraded they will have to pay higher interest rates to continue borrowing in the credit markets. And such downgrading is not likely to be confined to just five states. So far Moody and Fitch are staying with the AAA rating for the federal government.

The bottom line in all of this is that S&P, Moody, and Fitch by their in-house data and subjective political analyses have had or potentially will have a major negative effect on the financial markets, and all of the rippling effects are as yet unknown. If the TP and right wing extremists think the federal government is too big and too intrusive in our lives, what about these rating agencies who can and have already shaken the financial world here and abroad and have cost millions of us collectively to lose trillions of dollars in the 401k plans and other investments. We have heard disparagingly of "too big to fail;" how about "too arrogant to roam freely to scorch the financial earth."