By Michael Collins
Standard and Poor’s finally did it. They downgraded the credit rating of the United States from AAA to AA+. There are serious questions about the reliability of S&P. The White House pointed out that there is a $2 trillion error in the calculations used for the downgrade. Ths is of interest since the two other agencies failed to change the AAA status of the US. (See S&P downgrades U.S.)
Jack Tapper of ABC News reported:
“A third official says that S&P made a ‘serious mistake’ in its analysis, ‘based on flawed math and assumptions,’ so the Obama administration is pushing back. But even though ‘S&P has acknowledged its numbers are wrong, it’s unclear what they’re going to do,’ the official said.
“S&P’s numbers were off by ‘roughly $2 trillion,’ the official said.
Fitch and Moody’s reaffirmed the AAA US rating earlier in the week.
In addition to the question raised about a mathematical error, there are substantial reasons to doubt S&P for any credit rating, let alone the sovereign debt of the United States This material is from an article on April 25, 2011. It is highly relevant to the situation at hand.
They Helped Trigger the Financial Collapse
Along with Moody’s, S&P abruptly burst the real estate bubble and triggered the 2008 recession. Their downgrading of mortgage backed securities followed years of the highest ratings for these risky financial products. According to a US Senate committee report:
“Although ratings downgrades for investment grade securities are supposed to be relatively infrequent, in 2007, they took place on a massive scale that was unprecedented in U.S. financial markets. Beginning in July 2007, Moody’s and S&P downgraded hundreds and then thousands of RMBS and CDO ratings, causing the rated securities to lose value and become much more difficult to sell, and leading to the subsequent collapse of the RMBS and CDO secondary markets. The massive downgrades made it clear that the original ratings were not only deeply flawed, but the U.S. mortgage market was much riskier than previously portrayed.“
(Author’s emphasis) US Senate Permanent Subcommittee on Investigations, April 13 (p. 263)
Did S&P and Moody’s have a sudden epiphany about their ratings of risky investments?
The report goes on:
“The evidence shows that analysts within Moody’s and S&P were aware of the increasing risks in the mortgage market in the years leading up to the financial crisis, including higher risk mortgage products, increasingly lax lending standards, poor quality loans, unsustainable housing prices, and increasing mortgage fraud. Yet for years, neither credit rating agency heeded warnings – even their own – about the need to adjust their processes to accurately reflect the increasing credit risk.” US Senate Permanent Subcommittee on Investigations, April 13 (p. 268)
The Senate investigation found that S&P succumbed to pressure for AAA ratings from Wall Street and big banks for their very risky mortgage backed securities (MBS) and other financial instruments that fueled the real estate bubble. That pressure resulted in high credit ratings while, according to the report, S&P knew from 2003 on that there were “increasing risks” in the MBS market. It seems S&P succumbed to pressure from their customers on Wall Street and the big banks
“S&P Intentionally Underrates Public Bonds”
The heading above is a section title from the 2008 State of State of Connecticut complaint filed against S&P for “unfair and deceptive acts and practices in the courts of trade or commerce within the State of Connecticut.”
The Connecticut Attorney General issued the following statement after filing the complaint against S&P:
“We are holding the credit rating agencies accountable for a secret Wall Street tax on Main Street.
“All three credit rating agencies systematically and intentionally gave lower credit ratings to bonds issued by states, municipalities and other public entities as compared to corporate and other forms of debt with similar or even worse rates of default, Blumenthal alleges”
Richard Blumenthal, Connecticut Attorney General, July 30, 2008 (Blumenthal is now governor of Connecticut)
Section V of the complaint, referenced in the heading above, teaches us something about how S&P treats government entities.
“Since at least 2001, S&P has known that it underrates public bonds as compared to corporate bonds and that this policy costs public bond issues money in the form of higher interest costs or unnecessary bone insurance costs. Despite knowing these facts, S&P continued to represent that its credit ratings are on the same scale, that public issuers have the same credit risks as similarly rated corporations, and that public bond issuers with lower credit ratings have a greater likelihood of not paying their bonds than a bond issuer or corporate bond issuer with a higher credit rating. These knowingly false representations harm public bond issuers when the buy bond insurance based on their own ratings and bond buyers who consider S&P’s credit ratings when deciding to purchase public bonds.” (Author’s emphasis) State of Connecticut v. the McGraw Hill Companies (p. 12)
Here’s a credit firm that takes money from local governments and citizens by issuing ratings it knows are flawed. This is the same credit rating firm wielding major influence on theUSbudget process. There is no doubt that S&P’s influence will work against the interest of citizens.
The math error should be thoroughly examined. If the White House is right, S&P can withdraw their rating. If it’s not, the critique and attack on S&P credibility needs to be met at a very high level Paul Krugman has already begun. Others should follow. These people have no right to impact US economics and politics in any way, let alone one that has a major influence.
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