Former JPMorgan Managing Director John Fullerton compares the current S&P credit downgrade to the days when JPM lost its AAA shine. He recalls that while it hurt the psyche and bruised the egos of employees, in the end, it made them better. John through his 18-year career at JP Morgan, managed multiple capital markets and global derivatives businesses, and was Chief Investment Officer of JPM’s venture investment initiative, LabMorgan. John also represented JPMorgan on the contentious Long Term Capital Oversight Committee in 1997-98.
Only One Notch S&P?
I recall when JPMorgan lost its AAA rating. Those of us working there a long time felt the gloom of losing our specialness. The rating agencies were right — the truth hurt. Egos were stung. And they were late, as they almost always are.
No different with the downgrade of US Sovereign debt. Any rational, objective observer must conclude “too little, too late.” Apparently, neither Tim Geithner nor even Warren Buffett can remain objective in this situation. Nor was the senior management of JPMorgan when it was downgraded. Blame the messenger is a time tested strategy.
S&P’s full press release on the downgrade is available here. The headline reads:
United States of America Long-Term Rating Lowered To ‘AA+’ Due To Political Risks, Rising Debt Burden; Outlook Negative
The press release the rating agencies should have released on December 18, 2010, the day after Congress approved an extension of the Bush Tax cuts, reads as follows:
United States of America Long-Term Rating Lowered Two Notches to ‘AA’ Due to Political Risks, Weak Leadership, Rising Debt Burden, Virtually Unlimited Contingent Liabilities, and New Constraints on Long Term Growth; Outlook Negative
December 18, 2010
- We have lowered our long-term sovereign credit rating on the United States of America to ‘AA’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.
- The downgrade reflects our opinion, reinforced by the President’s capitulation on extending the Bush Tax cuts even on the wealthiest 1% of taxpayers, that Congress and the Administration are still not taking seriously the long term fiscal imbalances resulting from well understood demographic changes facing the nation, compounded by the $1.3 trillion hole (and growing) created by the Bush tax cuts at the same time the nation committed an estimated $3 trillion (including long-term health benefits and interest burdens) to fight two wars, and by the impact of the financial-industry-induced balance sheet recession which has exploded annual deficits to unsustainable levels.
- More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have dangerously weakened. Indeed, we observe a nation without strong leadership and virtually ungovernable at a time when restoring economic vibrancy and long-term fiscal prudence is essential.
- Furthermore, the recent financial crisis and the weak government response in addressing meaningful financial reform, and the ongoing success of financial industry interests in weakening what reform provisions were enacted, necessitates a fundamental rethinking of the contingent liability associated with the government’s debt rating. Nothing has changed that will prevent the government from having to underwrite the liabilities of the still oversized, misguided, and irresponsible financial industry at a time when its ability to do so has been severely weakened.
- The outlook on the long-term rating is negative. We might lower the long-term rating to ‘AA-’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.
- In fact, our base case of a stable 3% long-term growth rate already looks suspect, and our low case fails to anticipate any future crises despite an increasingly uncertain planning environment, significant risk of the euro-zone breaking apart with unpredictable implications for the US economy, and increasing likelihood that natural resource limits to growth, and negative feedback from overuse of waste sinks will increasingly crimp the long-term growth potential of the economy.
- We note the irony of one of the rating agencies playing the role of the adult in the room here, given our recent failures with disasterous consequences that directly lead to this action today, and our conflicted business model which we have chosen not to touch. But sovereign ratings are pretty easy compared to CDO squareds, and this call is a no brainer. Trust us. In fact, history will show we are late and timid on this one like we always are.
Category: Sustainable Small-B