The S&P Downgrade Market Plunge Myth

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 indebtedness.

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 debt.

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 banks.

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.