Apocalypse Never

Wasn’t the S&P downgrade supposed to bring down America? What happened?

Treasury Secretary Timothy Geithner
Deficit hawks wonder if Treasury Secretary Timothy Geithner and President Obama were crying wolf during the debt-ceiling crisis

Photograph by Mark Wilson/Getty Images

About three months ago, President Obama glowered into TV cameras and issued an apocalyptic warning about what would happen if a deal to increase the debt limit was not struck.

“For the first time in history,” said the president, “our country’s AAA credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet. Interest rates would skyrocket on credit cards, mortgages, and car loans, which amounts to a huge tax hike on the American people.”

The deal got done, zipped through Congress with two quick, emotional votes, then zoomed over to the president’s desk. And then … well, S&P downgraded America’s AAA rating anyway. That was the first unexpected twist, and it roiled markets and Washington for a week. It was followed by the second twist: None of that bad stuff the president mentioned ended up happening.

How could a saga that captured Washington for 11 weeks have faded so quickly? Why don’t the president’s enemies even talk about it as much as they used to? It’s pretty simple. America lucked out and avoided any of the really negative side effects because investors, in their panic, didn’t abandon U.S. bonds. The Dow Jones and S&P indexes are higher now than they were before the downgrade. Congress, worn to the ragged edge of sanity by the debt fight, moved on. Obama’s Republican rivals found other stuff to talk about.

Somehow, we dodged buckshot that was fired from three paces away. It’s impressive—and it doesn’t please investors or debt hawks at all. Actually, no: It’s another disaster.

“All of us budget wonks were ready to say ‘See! We told you!’” says Steve Bell, a former trader and current fellow at the Bipartisan Policy Center.

He remembers sharing a stage with Pete Peterson, the original debt Cassandra, and the two of them saying “Thank goodness!” when they heard about the downgrade.

Did he really hope for post-downgrade chaos? “This is why they call economics the dismal science,” he says. “I wish we’d had some! I know that now, more than ever, we need external panic to get anything done about the debt.”

We didn’t get that. Right before the downgrade, interest on 30-year fixed rates was at 4.42 percent. It’s at 4.22 percent now. The interest on 10-year Treasuries, then at 2.97 percent, is down to 2.22 percent. None of the things that were supposed to get worse after a downgrade actually got any worse.

We think we know why. Our salvation come in the form of desperation and gimmicks from the investors who might have abandoned our bonds.

“We got the downgrade, and everybody puked,” explains David Ader, head of government strategy at the Connecticut-based CRT Capital. “When you’re worried, you hold on to dollar reserves. After the downgrade, there was a sell-off in the stock market, because Treasuries were a better bet.”

In other words, so what if the U.S. Treasury bond that had been downgraded by only one rating agency? It was still one of the safest bets in the world; S&P was just one agency. The apocalypse never happened, and three months later, Americans are experiencing no short-term pain from the downgrade.

That’s what has Steve Bell so worried. The fear of a downgrade has slipped away. He’s often called to Capitol Hill to testify about what will happen if America doesn’t tackle its long-term debt. That was the issue with the downgrade; that what S&P warned about in its memo on the decision. But members of Congress were told to expect a disaster, and they didn’t get it.

“I hear from fairly solid people,” says Bell, “who say, ‘Boy, the fact that nothing happened doesn’t help your cause, does it?’ I say, ‘No shit.”

The political class, at least as Bell encounters it, has been lulled a bit by the lack of catastrophes. It forgets that Moody’s and Fitch could still downgrade the United States, and that Moody’s has been nice and transparent with its threat. One rating agency can’t do much to the reserve currency’s strength. Two could, though. That’s because there are an untold number of portfolios with requirements that require a certain amount of AAA bonds on the pile. Some of them will be forced to move the bonds if a majority of ratings agencies downgrades Treasuries.

Even when you consider that, we’re lucky. Some portfolios, including a lot of state pensions, require a certain rating level for most bonds they hold, but waive that requirement for Treasury bonds. That means the apocalypse could be put off even further, which is why the debt hawks are so worried. No crisis for Congress to panic about; no leverage for them to pass some combination of tax hikes and entitlement cuts.

That was exactly what S&P wanted, and it’s what Moody’s implies that it wants as it puts America’s bond rating on notice. When Obama warned of a Mad Max nightmare world of higher interest rates and falling dollars, he was trying to gin up support for a “grand bargain.” He had the pundit class behind him, led by Tom Friedman and his Mary Poppins bag of mixed metaphors. The world was about to collapse! If we don’t go big, the sky comes tumbling down!

The sky stayed where it was, so Congress moved even further away from something “grand.” This week, Democrats floated the idea of a $3 trillion supercommittee package, a combo of tax hikes and Medicare cuts, and Majority Leader John Boehner kicked it out of bounds: “I do think it’s time for everyone to get serious about this.”

This is the problem for deficit hawks: Too many members of Congress are convinced that the Treasury and the president called wolf. They think they were misled by the hopscotching “deadlines” set by Treasury Secretary Tim Geithner, by which the government wouldn’t be able to pay bills. They don’t know what to make of how the downgrade happened, and all they got was another zinger for some American Crossroads campaign ads. That’s moved Republicans back to zero, unwilling to revisit the issue of tax hikes, and convinced that they can reverse any cuts to defense even if the supercommittee fails them and $500 billion of defense spending is sequestered. The defense industry can prove how a crisis will hurt its bottom line. The Treasury? S&P? Moody’s? Not anymore.