Fitch Tells the Federal Reserve to Wake Up
The credit downgrade shows the urgency of rethinking regulatory, fiscal and monetary policy.
By David Malpass
Fitch Ratings’ headquarters in New York, Aug. 2. PHOTO: LEV RADIN/ZUMA PRESSThe essence of Fitch Ratings’ Tuesday decision to downgrade U.S. Treasury debt: We’re experiencing a slow-motion fiscal train wreck, not a “soft landing,” and it’s draining global capital and endangering the dollar.
The Congressional Budget Office’s June 28 report on the long-term deficit shows that the federal government expects to spend $160 trillion between 2024 and 2040, doubling the public debt.
Fiscal deficits would average more than 6% of gross domestic product during that period, well above the historical panic button of 3%, pushing average growth below 2%.
The Federal Reserve has been silent about the conflict between its mandate to provide price stability and the continuing fiscal blowout.
Its more than $7 trillion in bonds support Washington’s deficit spending by holding down bond yields, blurring the line between fiscal and monetary policy.
The New York Fed’s April Open Market Operations report describes a plan to buy trillions more in U.S. government bonds, apparently without regard to the issuer’s fiscal policies or bond rating.
This undercuts the central bank’s independence by exposing it to losses when interest rates rise.
It also undercuts growth, considering the Fed will have to continue funding its bond portfolio with interest-paying debt.
The central bank currently borrows $3.2 trillion from banks and $2.1 trillion in reverse repos from money-market funds, on which it pays 5.4% and 5.3% in interest, respectively.
That creates economic inequality by forcing the necessary savings for short-term floating-rate working-capital borrowers—the heart of private-sector dynamism—into long-term bonds.
The crowding out has harmed median income growth since the Fed started building its permanent government portfolio in 2010.
Rather than sound the alarm over this fiscal drain, regulators have protected the status quo.
Their power has ballooned since the days of the “Greenspan put” in the 2000s, when Wall Street expected the central bank to pause or cut interest rates to protect stock-market valuations.
The Fed can now do much more: by buying huge amounts of bonds, mortgages and repos outright and paying top interest rates to U.S. and foreign banks and money-market funds.
The regulators can also back large depositors after bank failures, as they did with Silicon Valley Bank in March.
These powers risk moral hazard—and each payment comes at taxpayers’ expense without the accountability of Congress’s appropriations process.
Fitch’s downgrade won’t change Washington’s embedded antigrowth policies, but it is a reminder that the numbers don’t add up and that financial markets worldwide still have to divide up the losses from months of rising interest rates.
Yet it’s still possible to salvage the U.S. growth model.
On the fiscal side, Congress needs to rewrite its debt-limit law so that it forces spending restraint—not debt default.
Regulators need to put additional onus on the financial system and capital markets to assess risk rather than avoid such assessments by imposing a blanket increase in capital requirements.
The latter course, which regulators have charted since SVB’s failure, will further reduce dynamism without making the financial system safer.
On the monetary side, the Fed should protect the dollar and recognize its major influence on the economy’s productive capacity.
The central bank should pivot from its bond-heavy balance sheet, which distorts capital flows, favors the wealthy and creates a conflict of interest with the Fed’s primary regulatory and monetary responsibilities.
The downgrade is a clarion call to rethink fiscal, monetary and regulatory policies.
With Europe, Japan and China nearly stagnant, the most important swing factor in the global growth outlook is U.S. private-sector innovation.
To reach its potential, that ingredient can no longer be stalled by regulatory mandates and government’s passion to grow and pick winners and—mostly—losers.
Mr. Malpass served as president of the World Bank, 2019-23, and undersecretary of the U.S. Treasury, 2017-19.
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