For more than three years after the U.S. government rescued Bear Stearns in March 2008, Washington used its own AAA rating to bring the credit of big financial firms up. Now, Washington’s failure to discipline itself — and to allow free markets to govern the financial world — is bringing the credit of the United States and of the financial firms that depend on it down.
S&P’s fiscal and political analyses, on the merits, are pedestrian. The company is saying what we already know. Debt has gone up — and is going up — and American politics can be, well, alarmingly robust. And S&P made a $2 trillion error in its original analysis, to boot — corrected only after the Treasury sent over a last-minute correction.
But, the Obama administration can’t really complain about S&P’s mediocrity. The White House has helped maintain S&P’s power by protecting the failed financial institutions that pay for ratings and thus pay S&P’s bills. (S&P rates the U.S. government for free, which may explain the downgrade.)
The S&P downgrade is bad enough. But the downgrades that have happened since last Friday night are significant, too. On Monday, S&P downgraded Fannie Mae, Freddie Mac, and the Army, Navy, and Air Force Exchange Services (which sell goods and services to military personnel) — plus 83 other entities that either depend on government guarantees or invest heavily in government securities.
“The downgrades of Fannie Mae and Freddie Mac reflect their direct reliance on the U.S. government,” S&P noted. The same is true for the rest of the bunch.
It’s these follow-on downgrades that are the most important signals to Big Finance and Big Politics alike. The conventional wisdom of Wall Street and Washington, for which S&P is a coat-holder, is starting to take notice of a crucial fact: The fiscal and political capacity of America’s government to protect Wall Street from free-market forces is finite.
Bondholders of large financial institutions such as Fannie, Freddie, Bank of America, Citigroup, and Goldman Sachs have got to think: Seven to ten years from now, with the U.S. government finally making choices on the entitlements issues that Standard & Poor’s is most worried about, is Washington really going to put such a priority on bailing out sophisticated investors of large financial institutions, as has happened since 2008?
When abstractions really become concrete — when it really comes down to it — will the U.S. choose Goldman bondholders again over American soldiers and retirees?
The government cannot protect everyone. And institutions and people are learning that they had better figure out where they rank in the pecking order. This explains why big banks’ stocks did so poorly on Monday, outpacing the broader market’s steep declines.
The same is true for Europe — and Germany, for one, should take heed. Since Greece began foundering more than a year ago, markets have expected that Germany would use its own credit to bring Greece up.
But now that Portugal, Italy, Ireland, and Spain have added themselves to the supplicant side, the risk has become more acute that instead of bringing the others up, credit-wise, Germany will allow the others to bring its own credit down, all in the service of protecting European banks’ creditors and stockholders from their own bad decisions.
It’s sad that it had to come to this. Because Western governments have not allowed free markets to discipline bad borrowers and bad lenders alike — by forcing them to accept losses for bad business decisions — free markets now must attack the sovereign credits of these Western governments.
Political leaders should understand: While governments won the first few battles against free-market discipline, starting back in 2008, markets will win the larger war, not governments. Hedge-fund guru George Soros proved this maxim nearly two decades ago, when he bet against the British pound’s artificial value until the British government finally, inevitably, caved in.
A nation that sacrifices essential free-market principles to obtain a little temporary growth will get neither.
— Nicole Gelinas is a contributing editor to the Manhattan Institute’s City Journal.