He Downgraded the U.S. a Decade Ago. He Stands By It.
(Bloomberg Opinion) -- No company or government likes a credit downgrade. Analysts might brace themselves for bitter phone calls or public rebukes of their analysis. It comes with the job.
John Chambers found out it’s a whole different ballgame when it comes to rating the U.S.
After he and his colleague David Beers at S&P Global Ratings stripped the U.S. of its AAA grade in August 2011, dropping it one level to AA+ for the first time in history, he says it wasn’t long before he received death threats. Chambers hired a bodyguard for a few weeks after the New York Post published a piece that attacked his credentials: “The Wall Street bean counter who trashed America’s global credit reputation is a New Yorker who never studied economics, majored in literature and philosophy, and has a master’s in English lit.” He discovered someone hacked his email and tried to drain his brokerage account. All for a downgrade that ultimately had no long-term consequences whatsoever.
Of course, S&P also received the typical backlash. U.S. officials were quick to cite a $2 trillion miscalculation that meant the country’s debt-to-GDP ratio would be lower than S&P’s projection of 85% in 2021. In hindsight, it was too low either way: The U.S. gross debt position as a percentage of GDP is more than 130%, according to the International Monetary Fund, and is only set to increase after the $1.9 trillion American Rescue Plan Act.
Chambers, the former chairman of S&P’s sovereign rating committee, comes off as neither a staunch deficit hawk nor a believer in Modern Monetary Theory. Rather, he says the Washington dysfunction that inspired the 2011 downgrade hasn’t improved much over the past decade, leading to inequality and an economy running below its potential.
I spoke with Chambers by phone on Monday. On Tuesday, current S&P analysts affirmed the AA+ rating he set almost a decade ago. This is a lightly edited transcript:
Brian Chappatta: In 2011, markets whipsawed almost daily on the debt-ceiling talks. Then lawmakers struck a deal. Then came the S&P downgrade. What do you remember most about that period?
John Chambers: The congressional brinksmanship motivated the 2011 downgrade. You had a clear — although perhaps remote — possibility that the U.S. government would default on its debt, triggered by the debt ceiling. The Federal Reserve had in place plans to unilaterally extend debt maturities, which for S&P would have been a default. And it’s a very bad rating transition to go from AAA to D. The fiscal position was a contributing factor, but the main factor was the political setting and the congressional brinksmanship.
BC: Proponents of MMT would argue that the U.S. can’t default on its debt because it’s the monopoly issuer of its own currency. Do you agree with that?
JC: We have examples of local currency defaults, and the U.S. government defaulted on its bonds in 1933. It can happen.
BC: Right, but that was abrogating the gold clauses.
JC: Yes, they repudiated the gold clauses in public and private sector contracts. We have a fiat currency, but you can think of other local currency defaults. Obviously there’s 20 ratings between AAA and D, and if you’re rated AA+ or anything in the triple-A, double-A, single-A category, the chances of default are remote. But there’s a gradation between indigo and navy blue that these ratings try to pick up.
BC: You and S&P were criticized for overestimating what the U.S. debt-to-GDP ratio would be in 2021. Now here we are, and it’s even higher than you thought, and the government just passed another $1.9 trillion in fiscal aid. How would you describe the country’s current fiscal position?
JC: One thing to remember is that the fiscal position of a government is just one element of its creditworthiness. The American Rescue Plan Act will weaken the country’s position, just the same way as the large corporate tax cuts of 2017 did. It will also probably do nothing to improve its trend growth rate because it’s not addressing public investment. But it may, however, strengthen the social contract. My view is this act is a political measure, and in the end it’s going to have to be evaluated in political terms. The social contract has weakened a great deal during my lifetime, and if the act comes to be seen as strengthening the social contract, it might be worth the cost.
BC: What do you mean by the social contract?
JC: According to Rousseau, you turn over a part of your liberty to be governed by central authority for reasons of security and for mutual benefit. And that has to apply to everybody in the country. And in the last 30 to 40 years, depending on how you count, 10% to 20% of the population has done very well and the other 80% has done less well, and people are beginning to resent that. You need a set of policies that brings everybody along.
BC: OK, so the fiscal position is worse relative to 2011. What about the other factors that S&P considered in its sovereign ratings? If you were still in your old seat, would another downgrade be on the table?
JC: You’d have to say the effectiveness of governance has improved lately. That would be on the plus side. But the fiscal position has deteriorated markedly. That’s on the negative side. And the rest is pretty much the same, the real economy, the monetary settings and the external position. Neither the Republican nor the Democratic parties have shown any ability to carry out countercyclical fiscal policy in good times. It’s one thing to have countercyclical fiscal policy in bad times, but you have to have some contraction when times are good. And we haven’t seen that. We didn’t see that in the four years running up to the election, and we’re not seeing it now. Now, you obviously don’t want to contract your fiscal position in the middle of a pandemic, but we already had a couple of measures that were fairly generous heading into this and will bear their fruit imminently, and now we’ve just enacted another front-loaded fiscal plan that’s going to add at least $1.9 trillion of debt.
BC: So based on everything you’ve seen from sovereign nations around the world, what’s the endgame?
JC: Eventually, there will have to be a fiscal correction. Or, if we don’t, in the extreme — default on the debt. Now, what’s likely to happen is there will be measures of financial repression and policy makers will slowly try to inflate the debt away. That would be one endgame, and that worked fairly well in the 50s and 60s, so maybe it’ll work again. It’s not your optimal solution. I think eventually taxes will have to rise, they’ll have to rise not only to adjust for what we’ve been doing the last few years but they’ll have to rise for increased health expenditures. Those will have to be fairly broad-based because you simply can’t get sufficient funds for what we’re talking about out of the superrich. And that can be done. But it takes a national consensus, it takes bipartisanship and it takes people taking a long-term view.
BC: Given what we know now, do you have any regrets about the downgrade?
JC: I think we’ve been validated — events have validated us. And again, although I don’t think the chance of a default because of a debt ceiling is that high as long as the Democrats control both Congress and the White House, that won’t always been the case. That could reemerge.
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Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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