Standard & Poors, the rating company that downgraded the debt of the United States to AA+ from AAA for the first time, now finds itself assailed by investors led by billionaire
Warren Buffett for making a political decision that has more to do with Tea Party politics than the financial stability of the U.S.
S&P officials, shrugging off a $2 trillion calculation error, blamed uncertainty in the policymaking process on Aug. 5 when they cut the assessment of the U.S. governments ability to pay its debt, citing Congresss failure to agree on as much long-term deficit reduction as the credit-rating company wanted. Buffett, the worlds most successful investor, said S&P erred and the U.S. should be rated quadruple-A.
The New York-based subsidiary of McGraw Hill Cos., whose inflated grades of mortgage-backed investments -- paid for by the banks that created the toxic debt -- were blamed by Congressional investigators for fueling the financial crisis, rattled investors around the world and provided fodder for President Barack Obamas rivals in the 2012 elections. U.S. equity futures fell, global stock markets tumbled, oil sank and gold rallied to a record.
Clearly the ratings downgrade was a political decision in the sense that the politics explained the timing of this, because the numbers have been irrefutable for a decade, said
Robert Litan, vice president for research and policy at the Kauffman Foundation in Kansas City, Missouri. It gives an enormous amount of ammunition to the Tea Party. They said the deal didnt go far enough and theyll say see.
Ratings Conflict
Litan, a former consultant to the U.S. Treasury, said yesterday in a telephone interview that he agreed with the downgrade, if not the timing. The charts that show exploding deficits have been around for over a decade, he said.
S&Ps decision was at odds with the other two main ratings companies, Moodys Investors Service and Fitch Ratings. Both affirmed their AAA grades on
U.S. debt on Aug. 2.
The new rating is the second-highest and puts the U.S. on the same level as Belgium and
New Zealand, and above Japan and
China. Under S&Ps definitions, debt rated AA is barely different from AAA securities and shows that a borrowers ability to meet its financial commitment on the obligation is very strong.
Markets Tumble
Gold futures surged to a record $1,715.17 an ounce as demand increased for a psychological store of value. Gold, one of 118 elements in the periodic table, pays no interest or dividends like equity or debt.
The dollar depreciated 1.2 percent versus the Swiss franc. Futures on the
Standard & Poors 500 Index expiring next month lost 2 percent after falling as much as 3 percent. Benchmark indexes in Australia and China tumbled, dropping more than 20 percent from their recent highs. The Stoxx Europe 600 Index fell 1.8 percent to 234.67 points as of 10:24 a.m. in
London.
Oil sank as much as 4.3 percent to $83.18 a barrel in electronic trading.
Members of Group of Seven nations agreed to inject liquidity into financial markets as needed and the
European Central Bank started buying Italian and Spanish bonds to curb the regions financial crisis, sparking a rally in the debt of the most-indebted nations.
Hurting Economy
S&Ps action may hurt the
U.S. economy over time by increasing the cost of mortgages, auto loans and other lending tied to the
interest rates paid on Treasuries. JPMorgan Chase & Co. estimated that a downgrade would raise the nations borrowing costs by $100 billion a year. The U.S. spent $414 billion on interest in fiscal 2010, or 2.7 percent of gross domestic product, according to Treasury Department data.
After weeks of debate, lawmakers agreed on Aug. 2 to raise the nations $14.3 trillion debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion that S&P had said it preferred.
S&P analysts David Beers and John Chambers said that the extremely difficult political discussions over how to reduce the more than $1 trillion
budget deficit carried more weight in their decision than the nations debt.
The debate this year has highlighted a degree of uncertainty over the political policymaking process which we think is incompatible with the AAA rating, Beers said on an Aug. 6 conference call with reporters.
Chambers, the chairman of S&Ps sovereign debt committee said in an interview on Bloomberg Television that this is a problem that has to be addressed by the full spectrum of political parties.
Obama Criticism
S&Ps decision provided Republican leaders with an opportunity to criticize Obamas administration.
Republican presidential candidate Mitt Romney, the frontrunner in most polls, said in a statement that the downgrade is a deeply troubling indicator of our countrys decline under President Obama.
Senator Jim DeMint, a South Carolina Republican and favorite of the fiscally conservative
Tea Party movement who voted against the debt deal, said the downgrade vindicated his decision. The deal was not a serious attempt to solve our spending and debt problem -- it was a political solution meant to kick the can down the road, he said.
Beyond Their Competence
Democrats disagreed. We have the people who helped cause the financial crisis now claiming that theyre the experts on what the American budget should be, Representative
Barney Frank, a Massachusetts Democrat, said in a telephone interview before the downgrade was announced. Its beyond their competence and Im just puzzled that people pay attention.
S&P maintained its AAA rating on the U.S. during George W. Bushs presidency as the national debt grew to pay for wars in Afghanistan and Iraq, tax cuts in 2001 and 2003, Medicare prescription drug benefits and the bailout of Wall Street. Together, those costs added $3.4 trillion to the national debt, according to data compiled by Bloomberg.
Obamas stimulus package will total $830 billion by 2019, according to a May 2011 Congressional Budget Office report, half the cost of the Bush tax cuts and less than two-thirds of what has been spent on the wars in Iraq and Afghanistan. The U.S. went from budget surpluses averaging $139.7 billion from 1998 through 2001 to a deficit of $1.29 trillion last year, Bloomberg data show. The shortfall peaked at $1.42 trillion in 2009, the first year of Obamas presidency.
BlackRock, Buffett
The debate will continue, said Litan. Our politics were dysfunctional before this and I think theyll be even more dysfunctional now, the former Treasury consultant said. Youre going to see a lot of finger-pointing.
BlackRock Inc., the worlds biggest money manager, and Buffett, the chairman of Omaha, Nebraska-based Berkshire Hathaway Inc., said the decision doesnt reflect any inability of the U.S. to pay its debts.
Treasury prices dropped, with the yield on 10-year notes falling 0.07 percentage point to 2.49 percent as of 10:19 a.m. in London. The yield on the benchmark fell to 2.4 percent on Aug. 4, the lowest since October, as the downgrade loomed. Strategists at JPMorgan said any drop in Treasuries from the ratings cut is unlikely to be sustained, while Barclays Plc said effects from the downgrade shouldnt be significant.
Theres been no lack of foreign demand for Treasuries. The amount of U.S. bonds held outside the country has risen to $4.15 trillion from $2.19 trillion in mid 2007.
Doesnt Change Anything
S&Ps move doesnt change anything about the risk of U.S. Treasuries, Peter Fisher, New York-based BlackRocks head of fixed income and a former undersecretary of the
U.S. Treasury Department, said in a Bloomberg Television interview.
Credit-default swaps that protect against default on U.S. notes for five years fell 11 percent last week to 55.4 basis points, CMA data show. That compares with an increase of 16 percent to 74.2 for swaps linked to Germany, an 18 percent climb to 143.8 for France, and a 4.5 percent increase to 77 for U.K. government securities. S&P rates those countries AAA.
Economists said S&P erred by basing its decision on politics instead of sticking to the assessment of the nations finances.
They think theyre giving an honest appraisal but they have instead become hopelessly entangled in the politics of the national debt,
Chris Rupkey, the chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in
New York, said in a Bloomberg Television interview on Aug. 5. The U.S. is not out of money, it has the financial resources to make good on its debt, and it should not have been downgraded.
$2 Trillion Error
John Bellows, the Treasurys acting assistant secretary for economic policy, said in a blog post that S&P initially overestimated future deficits by $2 trillion over 10 years. After Treasury pointed out this error -- a basic math error of significant consequence -- S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit-rating decision from an economic one to a political one, he wrote.
S&P said in a
statement that the revision lowered its forecast for the debt-to-gross domestic product ratio in 2015 by two percentage points and didnt affect its ratings decision. S&P said in the Aug. 5 report that the ratio of debt to GDP would reach 77 percent in 2015 and 78 percent by 2021.
In 2009, when S&P reaffirmed the U.S.s AAA rating, analysts led by Nikola Swann wrote that the ratio would approach 90 percent by 2013.
Always Wrong
The old fashioned ratings agencies where humans make the decision to downgrade are always wrong,
Christopher Whalen, managing director at
Institutional Risk Analytics, said yesterday in a telephone interview.
S&P came under scrutiny for ratings of financial products linked to subprime mortgages after losses and writedowns by the worlds biggest financial institutions reached $2.1 trillion.
The Financial Crisis Inquiry Commission called S&P and Moodys key enablers of the financial meltdown in its January report. In April, a Senate panel said that the rating companies engaged in a race to the bottom to assign top grades on mortgage-backed securities in order to win fees from banks.
S&P kept an A- rating on Iceland until October 6, 2008, when the countrys government was forced to guarantee all domestic bank deposits after its currency plunged. The company reaffirmed its AAA rating for Lehman Brothers Holdings Inc.s financial products unit on Sept. 12, 2008, three days before the bank failed. It downgraded Bear Stearns Cos. to BBB on March 14, 2008, two days before JPMorgan agreed to buy the failing securities firm.
Last People
There is no reason to take Fridays downgrade of America seriously, Nobel Laureate Paul Krugman said in a New York Times column. These are the last people whose judgment we should trust.
While S&P cut Japans credit rating to AA- in 2002, the country has no difficulty borrowing. Japans 10-year notes yield 1 percent, compared with 2.41 percent for AAA rated German bunds, Bloomberg data show.
In those rare cases where rating agencies have downgraded countries that, like America now, still had the confidence of investors, they have consistently been wrong, Krugman wrote.
S&P said in its report that the failure by politicians to act on increasing government revenue also was a consideration in its decision. It no longer assumes that the 2001 and 2003 Bush tax cuts would expire by the end of 2012 because the majority of Republicans in Congress continue to resist any measure that would raise revenues.
Politics as Factor
Politics is listed as one of five key factors in S&Ps methodology for grading governments. Part of our analysis assesses how government policymaking affects a sovereigns credit fundamentals,
Ed Sweeney, a spokesman for the ratings company, said yesterday in a telephone interview.
S&P gives 18 sovereign entities its top ranking. The U.K., with a debt estimated at 80 percent of GDP this year, or 6 percentage points higher than the U.S., has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P has said.
To downgrade you have to argue theres an increased chance that we wont pay our debts, said Peter J. Solomon, founder of New York-based investment bank Peter J. Solomon Co. and a one-time counselor to the Treasury Secretary under President Jimmy Carter. I dont think thats been proven, I think its been proven that we always will pay our debts.
Mismanaged Country
Solomon said yesterday in a telephone interview that politicians are wrong to criticize S&Ps decision. If I were a politician I wouldnt shoot the messenger, he said. This is really a mismanaged country.
Alice Rivlin, former President Bill Clintons budget director who served on a fiscal commission Obama set up last year, called the downgrade entirely symbolic.
S&P has no inside information and has done no original research, so they arent telling anyone anything they didnt know already, Rivlin said in an e-mail. It is not like downgrading a company or a complex security, where they might actually be contributing new information -- although their track record before the crisis doesnt inspire confidence there either.
