By Simon Johnson
Standard & Poor’s downgrade of United States government debt last month has been much debated, but not enough attention has been devoted to the fact, reported last week by Bloomberg News, that it continues to rate securities based on subprime mortgages as AAA.
In short, S.&P. is suggesting that these mortgages are more creditworthy than the United States government – a striking proposition. Leave aside for a moment that S.&P. made a big mistake in its analysis of the federal budget (as explained by James Kwak recently in this blog). Just focus on all the things that can go wrong with subprime mortgages – housing prices can fall, people can lose jobs, the economy may fall into recession and so on.
Now weigh those risks against the possibility that the United States government will default. As we learned this summer, that is not a zero-probability event – but it would take either an act of Congress, in the sense of passing legislation, or a determination by members of Congress that they could not act. S.&P. finds this more likely to happen than some subprime mortgages going bad. Continue reading