S&P seen surrendering to Tea Party with credit downgrade

Standard & Poor’s, 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. government’s ability to pay its debt, citing Congress’s failure to agree on as much long-term deficit reduction as the credit-rating company wanted. Buffett, the world’s 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 Obama’s 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 didn’t go far enough and they’ll 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&P’s decision was at odds with the other two main ratings companies, Moody’s 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&P’s definitions, debt rated AA is barely different from AAA securities and shows that a borrower’s ability to “meet its financial commitment on the obligation is very strong.”
Hurting Economy
Still, S&P’s 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 nation’s 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 nation’s $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 nation’s 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&P’s 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&P’s decision provided Republican leaders with an opportunity to criticize Obama’s 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 country’s 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 they’re 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. “It’s beyond their competence and I’m just puzzled that people pay attention.”
S&P maintained its AAA rating on the U.S. during George W. Bush’s 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.
Obama’s 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 Obama’s presidency.
BlackRock, Buffett
The debate will continue, said Litan. “Our politics were dysfunctional before this and I think they’ll be even more dysfunctional now,” the former Treasury consultant said. “You’re going to see a lot of finger-pointing.”
BlackRock Inc., the world’s biggest money manager, and Buffett, the chairman of Omaha, Nebraska-based Berkshire Hathaway Inc., said the decision doesn’t reflect any inability of the U.S. to pay its debts.
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 shouldn’t be “significant.”
There’s 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.
‘Doesn’t Change Anything’
S&P’s move “doesn’t change anything about the risk of U.S. Treasuries,” Peter Fisher, New York-based BlackRock’s 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 nation’s finances.
“They think they’re 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 Treasury’s 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 didn’t 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 world’s biggest financial institutions reached $2.1 trillion.
The Financial Crisis Inquiry Commission called S&P and Moody’s “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 country’s 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 Friday’s 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 Japan’s credit rating to AA- in 2002, the country has no difficulty borrowing. Japan’s 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&P’s methodology for grading governments. “Part of our analysis assesses how government policymaking affects a sovereign’s 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 there’s an increased chance that we won’t 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 don’t think that’s been proven, I think it’s 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&P’s decision. “If I were a politician I wouldn’t shoot the messenger,” he said. “This is really a mismanaged country.”
Alice Rivlin, former President Bill Clinton’s 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 aren’t telling anyone anything they didn’t 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 doesn’t inspire confidence there either.”
–Bloomberg News–