August 2011, Week 4


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Mon, 22 Aug 2011 00:41:46 -0400
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The S&P Downgrade Market Plunge Myth
Dean Baker
15 August 2011

The Wall Street crew that wants to cut your Social
Security and Medicare benefits are sensing that victory
is in sight. They have managed to knock jobs completely
off the agenda and have made deficit reduction the near
exclusive focus of economic policy in Washington. They
are now setting the stage to have the Congressional
"super committee" produce a deal that will mean large
cuts in both programs.

The backdrop for these cuts is that the country is in
crisis and that we have no choice. A central part of
this story is that the stock market crashed last week in
response to the Standard & Poor's (S&P) downgrade of US
government debt. The Wall Street crew and their allies
in the media and Congress will tell the country that if
we don't have the cuts in Social Security and Medicare
demanded by S&P then we run the risk of further
downgrades. This raises the prospect of further market
panics and the complete wreckage of the economy.

This story has as much credibility as John Edwards'
tales of marital bliss during his presidential campaign.
First, every informed investor knows S&P's sterling
track record of missing everything in sight. It gave top
investment grade ratings to hundreds of billions of
dollars of subprime mortgage-backed securities, to
Lehman until its bankruptcy, to AIG until its collapse,
to Enron until just before its collapse. They know about
its $2 trillion arithmetic error in assessing US

They also know that S&P, like the other credit rating
companies, is very concerned about the final wording of
rules that are being written as part of the Dodd-Frank
financial reform bill. That is why it is far more likely
that the downgrade was done with the hope of currying
favor from powerful political figures than out of the
belief that the government will be unable to pay its

This is why the markets completely laughed off the S&P
downgrade. Yes, the markets completely laughed off the
S&P downgrade. Let's say that a third time just so that
even a Washington Post editor can understand it: the
markets laughed off the S&P downgrade.

The S&P downgrade was supposed to mean that it is now
more likely that the US government will not be able to
pay its debt than previously believed. If the markets
took this warning seriously, then they would attach a
higher risk premium to US government bonds. That would
mean that bonds would fall in price and the interest
rate on government debt would rise.

But the exact opposite happened. US government bonds
soared in price. The interest rate on Treasury bonds
plummeted to less than 2.2 percent, near record lows. In
other words, investors voted with money as loudly as
possible that they view US government debt as a very
safe asset and that the S&P crew doesn't have a clue.

There is an obvious alternative explanation for the
stock market plunge, which also explains the flight to
government debt. The euro zone's debt crisis spread from
relatively small countries like Greece and Ireland to
the euro zone giants, Spain and Italy. If these
countries defaulted on their debt it would almost
certainly lead to the collapse of several major European

This, in turn, could lead to the sort of financial
freeze-up that we saw after the collapse of Lehman in
the fall of 2008. This would mean another economic free
fall with the economy shedding millions of jobs as
normal financial flows were blocked.

The euro zone collapse scenario is genuinely frightening
and can easily explain why the markets would be
panicked. But the moral of the euro collapse story is to
get competent people running the European Central Bank
who can prevent this sort of crisis. Cutting Social
Security and Medicare will not save the euro.

However, the Wall Street crew knows that most people do
not follow the economy and finances closely. So, they
just made up a bogus story with the hope that the
country would buy it. Thus far, they have already gotten
politicians and reporters to push their line that the
debt downgrade led to the stock market plunge.

Needless to say, those pushing for cuts in Social
Security and Medicare will freely use the story of the
downgrade market plunge to advance their agenda without
fear of ridicule from the media. As a result, we can
expect a continual parade of public figures saying that
we need big cuts in these programs in order to prevent
another market crash and economic collapse.

If these programs are to be protected, it is essential
that the public provide the missing ridicule. Any
politician who has so little understanding of financial
markets and the economy to blame the stock market plunge
on the downgrade should not be involved in designing
economic policy. Any reporter or columnist who makes
such a connection should be in a different line of work.

People who understand economics know that Social
Security and Medicare have nothing to do with the
country's economic problems. Unfortunately, such people
have been virtually excluded from the national economic
debate by the people with money who want to undermine
these programs.


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