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S&P in the dock | Are US government charges unfair?

S&P in the dock | Are US government charges unfair?
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First Published: Tue, Aug 09 2011. 12 02 PM IST
Updated: Tue, Aug 09 2011. 12 02 PM IST
New York: They didn’t just shoot the messenger, they tried to riddle the messenger with bullets.
The Treasury and the White House over the weekend did everything they could to attack the credibility and integrity of Standard & Poor’s after the agency on Friday night cut the United States’ AAA credit rating for the first time ever.
Whether it was questioning S&P’s math and professionalism, the politicization of its analysis, or accusing the agency of acting hastily and recklessly, the assault was nonstop.
In statements, press calls, on blogs and TV talk shows -- it was difficult to avoid hearing the case for the prosecution from current officials and those who recently left the government.
But how fair was the attack? Did President Barack Obama’s administration start to sound more like a Third World country bitterly complaining when told to get its financial house in order?
Past debt crises in emerging markets have shown that policy makers often react bitterly when their country is downgraded. The United States has proved that it is no different, says a former International Monetary Fund director.
“This is the common way of dealing with a downgrade, which is not the good way of dealing with it,” says Claudio Loser, who headed the IMF’s Western Hemisphere Department during the Latin American debt crisis in the 1990s. “The US government should have taken a much more balanced and mature approach.”
Others disagree, saying that the United States remains as good a credit risk as before and didn’t deserve such shoddy treatment. Legendary investor Warren Buffett was out and about on several cable networks over the weekend saying he didn’t understand the rationale. “If there were a quadruple-A rating, I’d give the US that,” he told Fox Business Network.
Here are the allegations one by one and S&P’s response:
Charge No.1: Unjustified
“There is no justifiable rationale for downgrading the debt of the United States.” -- John Bellows, acting assistant secretary for economic policy in the Treasury.
In an blog posted on the Treasury website, Bellows said the millions of investors who trade US government debt every day know that the United States has the means and the political will to make good on its payments.
He got support from Nobel Prize winning economist Joseph Stiglitz who said the ratings agencies continued their “remarkable track record” of misjudging risk. “They underestimated the risk of subprime failures and now they are overestimating the risk of a US default.”
It’s true that America’s ability to service its debt remains very high, as one would expect from a country rated in the double - A category after the downgrade. Still, its debt burden is projected to keep growing steadily to nearly 80% of its gross domestic product by 2015.
Triple A-rated countries such as Britain and France have a similar debt-to-GDP ratio, but S&P expects their public debt burden to begin to decline by 2015 or earlier.
But in the case of the United States, agreements to further reduce the deficit are less likely in the near future because the “effectiveness, stability and predictability of American policymaking and political institutions have weakened,” S&P said in its announcement of the downgrade.
The top S&P official behind the ratings move, head of sovereign ratings David Beers, said that these “political dynamics” had been highly influential in its decision.
Charge No. 2: A $2 trillion mistake
“The basic case is they made a $2 trillion math error and forgot to check their work.” -- Austan Goolsbee, who stepped down on Friday as chairman of the White House’s Council of economic advisors on NBC’s “Meet The Press.”
Bellows also talked of “a basic math error of significant consequences,” saying it had “led to a very misleading picture of debt sustainability.”
The charge is that S&P initially miscalculated the US debt burden by $2 trillion for the next 10 years and, when confronted by the Treasury Department, changed its estimates but not its decision to downgrade the United States.
S&P confirms it changed its calculations after conversations with the Treasury, but maintains that the substance of its concern about growing debt and deficit burdens and the lack of clear political will to deal with them didn’t change as a result.
The $2 trillion discrepancy comes from two different economic scenarios forecast by the nonpartisan Congressional Budget Office -- one that assumes government discretionary spending will grow at the same pace as GDP, and the other that assumes it will expand at the pace of consumer inflation.
Under the first scenario, US debt levels would swell in the next 10 years to $22.1 trillion, or 93% of GDP, from an estimated 74% at the end of 2011. Under the second one, the debt load would reach $20.1 trillion, or 85% of GDP.
“The underlying point remains the same,” said John Chambers, the chairman of S&P’s sovereign ratings committee. “The fiscal trajectory continues to deteriorate over the horizon. Nobody disputes that.”
The estimates will, of course, likely change considerably if the US economy sinks into another recession later this year or next year, as some think is possible. That would reduce tax revenue and likely boost welfare spending, likely adding further to deficit projections.
Charge No. 3: Too political
“I think they drew exactly the wrong conclusion from this budget agreement.” -- treasury secretary Timothy Geithner on NBC/CNBC television.
Other officials weighed in, suggesting that not only was the analysis wrong but S&P had emphasized political considerations over its economic assessment far too much.
It’s true that political risks have a large weight on S&P’s analysis -- they account for about one quarter of the analysis, the agency says. But to suggest that ratings agencies should focus on numbers and not on politics is nonsense, argues Beers.
“Any analysis of economic policy and certainly fiscal policy has to be based on the recognition that these decisions are taken in the political arena,” he said. “That is as much true for the United States as it is for Brazil, France, Greece or any other country.”
At the end of the day, the ratings agencies’ job is to predict borrowers’ ability and willingness to pay their debts - and politics play a major role in both.
The US debt ceiling debate, which took the country to the brink of default, cast a veil of uncertainty on future policy making which is not compatible to a AAA-rated country, S&P argued.
And some investors agreed with the view:
“What S&P was focusing on was willingness to pay, not ability to pay,” said Jerry Webman, chief economist and senior investment officer with Oppenheimer Funds in New York. “The concern is whether it is politically possible to get to a stabilized debt situation. They’re saying that there’s scant evidence of that, and they have a point.”
Charge No.4: Hasty decision
“The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in the press release once the error was pointed out was breathtaking,” The White House’s National Economic Council director Gene Sperling said in a statement. “It smacked of an institution starting with a conclusion and shaping any arguments to fit it.”
While some in Washington seemed shocked about how fast S&P decided the downgrade -- just a few days after Washington agreed on a deal to make at least $2.1 trillion in budget savings -- the message had been well telegraphed and few investors were taken off guard.
Indeed, a look at countless brokerage reports and media articles before and immediately after the downgrade said it was expected or likely.
“These issues have been well aired for quite some time,” Beers told Reuters. “I think market participants, our key audience, understand well the analytics that we’re talking about versus the criticism that we’re getting.”
Time will tell whether S&P moved too fast this time. Only a few years ago, the agency was being accused of failing to spot the US subprime mortgage crisis in time.
Charge No.5: Terrible track record
“S&P’s record has been terrible, and as we have seen this weekend its arithmetic is worse. So there’s nothing good to say about what they’ve done.” -- Larry Summers, former director of Obama’s National Economic Council on CNN’s State of the Union.
S&P is a particularly easy target because it was one of the rating agencies accused of helping pave the way for the financial crisis by being too slow to downgrade the AAA ratings of questionable mortgage-backed bonds.
But this time S&P is being attacked for taking action to protect investors by signaling through the downgrade that it doesn’t think the US is as good a credit risk as it was, rather than for being tardy.
Some analysts see it as a bold move to restore the agency’s credibility after the financial crisis. It is a move that come with many risks, including the possibility of a political backlash through increased regulation of the ratings agencies.
But S&P says it is not afraid. The Dodd-Frank regulatory reform law introduced last year was not as tough on the ratings agencies as some lawmakers wanted.
“We are pleased that the new legislation very plainly says that regulation, among other things, is designed to support and safeguard our independence,” Beers says.
“It means that we’re going to deliver messages that folks and authorities do not always agree with.”
The US Senate Banking Committee has already begun looking into the decision to downgrade the United States but has not yet made a decision on possible hearings.
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First Published: Tue, Aug 09 2011. 12 02 PM IST
More Topics: US debt rating | S&P | US | Debt crisis | Investors |