S&P Pantsed by US Treasury

I have been reluctant to condemn the credit-rating agencies for sovereign downgrades because it seemed like shooting the messenger. As the bond markets have noticed, a few European countries have serious fiscal problems. Blaming the raters for also noticing did not seem like an effective response.

However, I think that Standard and Poor’s decision – alone among the major raters – to downgrade the US has severely discredited the agency (bad pun intended). The US Treasury has posted a stinging note about a calculation mistake underlying this decision. Interestingly, the magnitude of S&P’s error was equal to the amount by which it judged the US deficit-reduction plan to fall short: $2 trillion over ten years.

Paul Krugman emphasizes the amateurish nature of S&P’s mistake. But what strikes me is that, when Treasury officials pointed out the error, the agency just changed its main rationale for the downgrade and immediately proceeded with the public announcement. It seems that S&P had made up its mind and did not want to be confused by the facts.

A few commentators have tried to defend S&P by claiming that its initial assumptions were as legitimate as, or more realistic than, the Treasury’s assumptions. I am no expert on American budgeting, but I do not think that is the issue.

My reading of the Treasury’s post is that S&P costed the deficit deal based on one assumed baseline and then subtracted the result from a different baseline. Doing so would be wrong, whichever baseline is right.

UPDATE (August 7): Andy Watt from the European Trade Union Institute has more.

UPDATE (August 8): Krugman has more.

UPDATE (August 8): Some US blogs have already posted this statement by David Levey, Director of Sovereign Ratings at Moody’s from 1985 through 2004. I would argue that US taxes are too low more than that they are “distortionary,” but he makes some good points about the downgrade.

The recent S&P downgrade of the credit rating of US Treasury bonds is unwarranted for the following reasons:

1) The US dollar remains the dominant global currency and no viable competitor is on the horizon. The euro is heading into dangerous and uncharted waters while deep and difficult political, economic and financial reforms will be required before the renminbi could become fully convertible for capital flows and Chinese government bonds a safe reserve asset.

2) US Treasury bills and bonds, along with government-guaranteed bonds and highly-rated corporates, will for the foreseeable future remain the assets of choice for global investors seeking a “safe haven,” due to the unparalleled institutional strength, depth and liquidity of the market. Although there are several advanced AAA-rated OECD countries with lower debt ratios and better fiscal outlooks than the US, their markets are generally too small to play that role. Since ratings are intended to function as a market signal, it makes little sense to implicitly suggest to investors seeking “risk-free” reserve assets that they reallocate their portfolios toward these relatively illiquid markets.

3) Despite the above positive factors for the US, it is certainly the case that the US long-term debt outlook is deteriorating under the pressure of rising entitlement costs and an inefficient, distortionary tax system. Failure to reverse that trajectory would eventually make a downgrade unavoidable. But the recent discussions signal to me that – finally – public awareness of the fiscal crisis is growing and beginning to influence Washington. There is still a window of time – perhaps as much as a decade – within which structural reforms to spending programs and the tax system could reverse the negative debt trajectory.

4) The bottom line is that the global role of the dollar and the central position of US bond markets make somewhat elevated debt ratios more compatible with an AAA rating than is the case for other countries, another version of the US’s “exorbitant privilege.” But that extra leeway is finite and serious reforms to entitlement programs, particularly Medicare, must be made in a reasonable time horizon. If not, global investors will eventually conclude that our political system is incapable of making the needed changes and turn away from US assets, regardless of the institutional strengths of US markets.


  • When one considers the potential ramifications of this downgrading, given the timing, I must say it was a highly highly highly and costly irresponsible action by the S&P. MAke you wonder who is running that place, this could stir the whole nasty economic cocktail that has arisn in the last couple weeks into a frenzy that markets could really start bursting and then we have another banking crisis, as the reforms that were put in place after the last bust up, will not prevent over leveraged bankers from having to further deleveraging and then we get another run on the banks, credit freeze ups and the whole thing will not be backed up by sovereign debt rescuing- and finally we will be at that point where the too big to fail- fails.

    So in other words, S&P knows this pathway, undoubtely, and chose to downgrade in the middle of a nasty storm, so it’s as iff they actually want to provoke another crisis. My question, if that is accurate, why? and for who does it benefit?

  • There is no rational reason why the US should default given that there is lots of room to raise taxes and to cut wasteful health care spending so as to narrow the deficit, and, also given that the Federal Reserve can always finance the US Government and pay creditors. However, the Republicans were and probably still are prepared to threaten default and oppose rational economic policies. So, it is hard to dismiss the possibility of a future default. n’est ce pas.

  • I agree that Republican craziness undermines US credibility and would have more respect for S&P if it had just said so rather than overstating the fiscal challenge. However, failing to raise the debt ceiling would not automatically force a default. The administration could continue interest payments instead of other expenditures or pursue various constitutional options to circumvent the debt ceiling.

  • True that Andrew. There is nothing technical which implies the US ever needs to default. The politics however is now so kooky that it seems reasonable to demand a premium.

  • Warren Mosler calls the rationale of the downgrade into question. The only question for the sovereign issuer of the currency in which the debt is denominated is willingness to pay ~ ability to pay is guaranteed. So, whatever the credibility of the rating ~ given the recent political hijinks in the US Congress ~ basing the downgrade on a presumed question about ABILITY to pay is either intellectually confused or intellectually dishonest.

    Based on discussion with someone inside S&P acknowledging to him that a sovereign issuer of currency cannot be forced into default on debt denominated in that currency, Warren reckons its intellectual dishonesty.

  • @ Bruce

    Except that political instability (as opposed to technical ability) is one of their criteria. I think their is broad consensus on the political instability and even Geithner said as much. That said I put S&P’s downgrade as an aspect of the circus of greed that is the political economy of US right now.

  • I’ve been more or less assuming S&P has some kind of deal involving some sophisticated variant of “shorting”. They have a bet in, or some friend has a bet in, and they’re pushing to make sure the bet goes the right way. Unfortunately, for the bet to pay off the world economy has to take a hit. Omelets, eggs.

    So I guess I’m agreeing that this isn’t good for their credibility, at least as honest raters of commodities. But did they have any of that stuff? These are the people who went around rating exotic and toxic subprime mortgage confections triple-A, right?

    I was talking to my father, and he pointed out to me that much less in the news but perhaps more significant, some official Chinese rating agency has also downgraded the US. Given how much US debt the Chinese hold, and how much the US depends on them to buy more, this move would seem at any rate less meaningless than the S&P one.

  • “I agree that Republican craziness undermines US credibility and would have more respect for S&P if it had just said so rather than overstating the fiscal challenge.”

    Based on the articles I read, they did say so.

    I’d wouldn’t lend $10 to them in the state their in.

  • Markets down by 400 points this morning on the TSX and 330 on the DOW, so if the S&P was part of some grand short, then they made their money.

    Irresponsibility at the highest of levels. Dollar is almost back to parity, and its linkage to oil is more dramatic then ever. We need to get ourselves off this oil /dollar linkage.

  • @ Paul,

    Well if the US admin was not smart enough to have a get shorty program in place for this morning it is further evidence that they are part of the big short conspiracy.

  • As Erin points out not passing the debt debt ceiling would not cause default as interest payments on US treasury securities are not a very large part of US government expenditures.
    The problem was that if the US government had been forced to only spend the same amount it collects in taxes, it would have removed 9%’s worth of spending from the economy (the deficit is about 9% of GDP) and started a catastrophic deflationary spiral.

  • Denise Freedman

    I’m not sure why this “Nationally recognized statistical agency” is treated with such kid gloves; it seems like the way Catholics treat The Vatican–even when they have given up on the idea of rhythm.

    The farce–way beyond Kabuki–that I, for one, could not watch, may well be symptom of dysfunction, but it was clearly stage-managed by a far right-wing political faction, abetted not by a weak, or inept, but a truly enthusiastic operative for his own paymasters–even as Thomas Ferguson in his investment theory of politics has pointed out.

    For myself, I can barely contain my disgust for the way the same people who caused the crisis Americans, and the rest of us–mostly Americans–have hardly survived, the disciples of Robert Rubin, are the very people this political operative has “audaciously” kept to run his banana republic.

    One can only wonder at what our branch plant operative will do, when the only export of any real value, gold, will not do much other than fatten the bank account of Peter Munk.

    “We” have long accepted the very same reactionary notions of how to “build” a country: flatten it down until we are too poor even to afford to enrich the Walton family.

    Jets will not keep much money in Canada.

    Disaster relief seems to have passed out of our concern; when was the last time anyone heard of DART? And without the weather scientists–who will probably end up at Walmart–to warn us, the very environmental disasters our political economy causes will become the very model for our economic disasters: pick up only a few of the pieces; let the rest rot.

    Maybe we should all line up to build prisons and work in them, just like they do in the US; they build more prisons than schools; there’s more money in prisons because there will surely be more “criminals” when the decent work continues on its several decades’ disappearance.

    And we will have to learn to contain our nausea–as long as we can actually feel nausea–at all the morally inspired “denunciation” and “deterrence” that is the favourite mode of our government and our fearless leader.

    I fear there may be no “leader” who can capture the anger that will rise in response; except one who will capture the fear and loathing to take us further and faster down this path.

  • @Denise

    AMEN. And thank you. This is a degree of honesty and insight completely absent in the mainstream commentary and info-tainment corporate propaganda outlets – which Chomsky, several years ago astutely and correctly identified as part of the “Doctrinal System”.

  • According to Zero Hedge, countries outside of the U.S. dumped 74 billion dollars in U.S. Treasuries, most of it over the weekend:

    “Over the weekend, we observed the perplexing sell off of $56 billion in US Treasurys courtesy of weekly disclosure in the Fed’s custodial account (source: H.4.1) and speculated if this may be due to an asset rotation, under duress or otherwise, out of bonds and into stocks, to prevent the collapse of the global ponzi (because when the BRICs tell the IMF to boost its bailout capacity you know it is global). We also proposed a far simpler theory: “the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity (although not with the element of surprise – China has made it abundantly clear it will sell its Treasury holdings, the only question is when), has finally arrived.” In hindsight the Occam’s Razor should have been applied. Little did we know 5 short days ago just how violent the reaction by China would be (both post and pre-facto) to the Senate decision to propose a law for all out trade warfare with China. Now we know – in the week ended October 12, a further $17.7 billion was “removed” from the Fed’s custodial Treasury account, meaning that someone, somewhere is very displeased with US paper, and, far more importantly, what it represents, and wants to make their displeasure heard loud and clear. (Source)

    Undoubtedly, the Chinese and other countries have recently discovered that Italy and Greece, with smaller debt to income ratios than the United States, are less riskier and carry a higher rate of return. This is because, unlike the US, the Rothschild/Rockefeller bond rating agencies have trashed their country’s debt ratings, forcing them to pay a much higher interest rate than U.S. Treasuries. Hey, if you take the risk, you might as well earn the reward!

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