- The Washington Times - Monday, August 8, 2011

The historic downgrade of the United States engendered by political gridlock in Washington caused one of the worst days ever on Wall Street Monday, with the Dow Jones industrial average plummeting more than 600 points in its sixth-biggest drop.

Standard & Poor’s cut in the once-untouchable U.S. credit rating to AA+ from AAA late Friday night shook global markets and added to worries that the world’s largest economy is sinking inexorably toward a double-dip recession.

In a panicky day of tumultuous trading on Wall Street, even a pledge by President Obama to double down on efforts this fall to come up with a major debt reduction plan that would satisfy ratings agencies did nothing to console markets.

“Markets will rise and fall,” the president said at an impromptu White House appearance in midafternoon. “But this is the United States of America. No matter what some agency may say, we’ve always been and always will be a AAA country.” But the Dow, which was down about 400 points when Mr. Obama appeared, only deteriorated further and lost another 200 points.

After a day of wild swings and record-making carnage from Tokyo to New York, the Dow ended down 635 points or 5.6 percent at 10,809. The Standard & Poor’s 500 index of blue chip stocks and tech-heavy Nasdaq composite index both lost a breathtaking 6 percent of their value in one trading session.

Asian stock markets plunged further Tuesday. In Japan, the benchmark Nikkei 225 index of the Tokyo Stock Exchange fell 4.07 percent, or 370.58 points, to 8,726.98 in midmorning trading, adding to a 2.18 percent plunge on Monday. South Korean shares also shot lower, dropping more than 5 percent, with the benchmark Kospi index down at 1,775.78.

The market was merciless. Even the most optimistic investors viewed their cumulative losses of more than 15 percent since the end of last month and gave up hope, scurrying into safe havens for shelter from the storm. Oil prices plunged in tandem with stocks by 6.4 percent to $81.70 in New York, erasing gains for the year. Gold prices soared to new record highs over $1,700 an ounce.

In perhaps the greatest irony of the day, investors piled into U.S. Treasury securities targeted by the downgrade — showing they have not lost their appeal as a refuge from the storm. The yields on 10-year Treasury bonds swooped as low as 2.34 percent.

“The world, not just the U.S., is in uncharted waters,” said Doug Cote, chief market strategist at ING Investment Management. “All the ramifications of a debt downgrade of the global reserve currency are unfathomable at this time,” which is why stock investors have moved to the sidelines to await further fallout from the S&P decision.

Besides setting off a cascade of downgrades on other borrowers throughout the country, Mr. Cote noted that S&P is threatening to further downgrade the United States if Congress doesn’t stand by its commitment to enact at least minimal spending cuts of $2.1 trillion this fall or if economic growth deteriorates and starts to subtract from government revenues again.

More downgrades

S&P followed through on its downgrade of the United States on Monday by downgrading commensurately the ratings of major financial institutions that rely on the federal government for funding, including mortgage giants Fannie Mae and Freddie Mac, and most of the Federal Home Loan banks.

“It amounts to a vote of no confidence in the U.S. government,” said Nigel Gault, chief U.S. economist at IHS global Insight. “The U.S. political process is at present unable to deliver a long-term fix to stabilize the debt.”

Despite the downgrade, Mr. Gault said investors still view the U.S. Treasury market as “by far the largest and most liquid in the world, with no equal, and a relative safe haven in times of global stress.” U.S. bonds also are benefiting by comparison to the bonds of even more heavily indebted European countries like Greece, Spain and Italy, he said.

John Alan James, a professor at Pace University’s Lubin School of Business, agreed.

“Equities will go down for a while because of increased market uncertainty and equal or better returns from rising fixed income investments,” he said. But, “U.S. Treasuries will actually increase in attractiveness as Europe and the eurozone grapple ineffectively with their own multiple sovereign debt problems.”

But like S&P, Mr. James is not optimistic that the crisis created by the downgrade will prompt warring factions in Congress to get together and enact a major deficit reduction agreement like the one sought by Mr. Obama.

“Nothing of any consequence is going to happen legislatively in the U.S. Congress until the elections in November 2012,” he said. “Members of Congress and the White House will never get serious about tackling the deficit and debt problems until they see their careers in jeopardy.”

The major differences between the two parties quickly re-emerged, as did the finger-pointing and political bickering that led to the downgrade. Republicans quickly denounced Mr. Obama’s call for additional tax cuts and spending measures to boost the economy and stimulate jobs in the short term, even as Congress works to slash deficits over the longer term.

House Speaker John A. Boehner, Ohio Republican, agreed with Mr. Obama that Washington must redouble efforts to come up with further curbs in federal spending. But he quickly raised a major sticking point with Democrats by again ruling out tax increases.

S&P and most independent experts say the magnitude of the U.S. debt problem is so great that it will require both increased revenues and major spending cuts and reforms in entitlement programs like Medicare and Social Security.

No more tax cuts

S&P executive David Beers, for example, said Mr. Obama could single-handedly improve the outlook for the U.S. by vetoing any attempt to extend President George W. Bush’s tax cuts, which expire at the end of next year.

But because those tax cuts have been extended repeatedly in the past, including once last year with Mr. Obama’s assent, S&P said it is assuming that the cuts will remain in place and that the debt will mount to unsustainable levels as a result.

“The S&P downgrade was important and based on the intransigence of politicians,” said Dean Croushore, a former economist at the Federal Reserve Bank of Philadelphia. “It makes complete sense” in light of the “bleak” outlook for the U.S. economy and government deficits.

Mr. Croushore said people shouldn’t get overly concerned about the possibility of a double-dip recession, though the odds of that have increased recently mostly because the government has run out of options for boosting the economy while consumers, businesses and investors have grown so pessimistic that they could bring on a recession if they stop spending and hiring for much longer.

The panicky sell-off in global stock markets in recent days, which has erased trillions of dollars of wealth worldwide, in itself increases the chances of recession, analysts say.

Despite this, “it’s certainly not a time for panic” because the economy is more solid than it appears, said Mr. Croushore. “What we should expect is that things should be mediocre for months to come. Historically, these economic crises take years to recover from.”

The Federal Reserve is expected to consider whether to try to further boost the economy through the limited means at its disposable at a meeting of its rate-setting committee scheduled for Tuesday.

While many Fed-watchers expect the central bank to take action, the Fed has run out of major options and analysts are not optimistic that it will be able to make a big difference for the markets or the economy at this point.