- S&P’s New Distinction
It was a painful and costly price to pay for a rebuke, but it is a rebuke nonetheless.
Yesterday, S&P’s decision to downgrade the credit rating on US debt from AAA to AA+ – based on the uncertainty of repayment of that debt – catalyzed a global financial panic that cost investors $1.2 trillion on the Dow Jones alone.
But in the middle of the panic, where did global investors go seeking a safe harbor for their money? Into the very instruments that S&P had concluded were no longer as safe because of an anticipated unstable debt load.
As the Dow, NASDAQ and other indices ticked down to one of their worst days since 2008, the flood of cash into American issued Treasuries actually pushed yields down. Had S&P been right, their would have been a flight from Treasuries.
A more authoratative – and damning – indictment is hard to imagine.
Outside the windowless cubicles of S&P financial chicken-hawks – with their spreadsheets, slide-rules and smug assurance – real investors with real money raised a collective middle finger to S&P’s imprudent judgement.
And with good reason.
96 hours into S&P’s downgrade, the fundamentals of the decision cannot withstand scrutiny.
The Washington Post’s Ezra Klein writes a devastating piece today, exposing S&P’s faulty logic.
In the lead up to S&P’s Friday determination, US Treasury officials pointed out that S&P’s math regarding US budget deficits in the out years was off by as much as $2 trillion. When S&P realized this, they deleted the math from the executive summary, but that is inconsistent with the calculations that S&P left in the final report.
According to Klein, both versions of the S&P report stated that the agency would upgrade its outlook from “negative” to “stable” if the Bush tax cuts expire for incomes over $250,000 – as they are scheduled to do in December. According to a static view of the impact of tax increases, that would net the Treasury $900 billion over ten years.
So $900 billion is the magic figure to get to “stable.”
But wait.
Klein shows, S&P’s original report stated that net public debt would drop from 93 percent of GDP in 2021 to 87 percent of GDP if the Bush tax cuts are allowed to expire.
But here’s the problem.
After S&P corrected the $2 trillion mistake, it revised US debt projections to be 79 percent of GDP by 2015 and 85 percent by 2021.
As Klein shows, S&P’s technical correction alone improved America’s deficit outlook sufficiently to maintain a “stable” rating, even if the Bush tax cuts for those making over $250,000 were extended.
“By S&P’s own logic, that should have changed the agency’s opinion of our finances,” Klein said.
As if this wasn’t enough, Klein points out that S&P insisted that a $4 trillion deficit reduction deal was required to tame the US debt trajectory, and found the $2.4 trillion in cuts passed by Congress last week to be wanting. But critically, S&P’s analysis here did not take into account the $2 trillion accounting mistake.
If you add the debt ceiling cuts to the correction, the US has exceeded S&P’s target to earn a “stable” rating.
But S&P went ahead with the downgrade anyway.
It is nothing short of stunning and willful incompetence.
Shone of any analytical integrity whatsoever, it his hard to see the S&P decision as anything but a thinly veiled political critique. That is as inappropriate for a ratings agency as the decision has been catastrophic for the markets.
This Journal has documented the rise of three powerful economic forces over the past two years. The failure of Obama administration policies and stimulus to trigger organic, sustained private sector led economic growth, the unsustainable growth in US debt, and the creeping expansion of the sovereign debt crisis in Europe.
All three forces are coming to a head at roughly the same time, reinforcing each other in a spiral of uncertainty that threatens global economic stability.
From that view, S&P’s decision can be seen as a “Archduke Franz Ferdinand” moment – were an isolated assassination of an Austrian political official in Sarajevo in June improbably led to the German army marching for Paris in August – a catalyst for the tragedy of WWI.
In this context, S&P’s decision was both unwarranted and unnecessary. But having made it, we must all now live with the consequences as the downgrade factors into a structural debt crisis around the globe.
To paraphrase Churchill, never have so few, acting so recklessly, done so much, to harm to so many.
Al Qaeda could only wish to be as destructive to the US economy as a division of American publisher McGraw Hill has been in a single day.