Mike the Mad Biologist

There’s been a lot of excellent posts debunking Standard & Poor’s recent downgrade of U.S. debt on the merits–it is poor assessment of risk. Yes, there are substantive economic arguments against S&P’s evaluation. But S&P is also fundamentally corrupt. The Coalition of the Sane must point this out too–there is an ethical dimension here, not just an economic one.

The critical point is this: during the last year, every negative statement by S&P has followed action by the federal government to investigate possible fraud by S&P (and other ratings agencies) during the mortgage crisis (bringing new meaning to the phrase “motivated reasoning“). This is not an intellectual error, but a political move:

But perhaps the biggest thing that happened on April 13:  A bipartisan study on the financial crisis from the Coburn-Levin Senate Permanent Subcommittee on Investigations released a report saying the credit ratings agencies were a “key cause” of the financial crisis. They issued a 650 page report, which included the following recommendation (p. 16):

The SEC should use its regulatory authority to facilitate the ability of investors to hold credit ratings agencies accountable in civil lawsuits for inflated credit ratings, when a credit rating agency knowingly or recklessly fails to conduct a reasonable investigation of the rated security.

Two days later, David Beers reached out to Undersecretary Goldstein to let Treasury know that the Standard and Poors committee has changed its outlook to “negative.” OnApril 18: Standard and Poors issued press release downgrading the outlook for US sovereign debt from stable to negative and giving a 30% chance of a ratings downgrade from AAA to AA.

“U.S.’s fiscal profile has deteriorated steadily during the past decade and two years after the financial crisis” they say — with no mention of their own role in that crisis. And whereas the October threat had been based on concerns over Social Security and Medicare, the latest press release contained no mention of either.

And it’s pretty clear, they’re trying to deliberately influence the Security and Exchange Commission (SEC):

In the midst of all of this, the SEC was moving to implement Dodd-Frank in ways that would negatively impact all the ratings agencies, and looking into S&P’s role in the 2008 mortgage crisis:

  • May 18:theSEC commissioners “voted unanimously to propose new, tougher regulations for credit rating agencies,” which would “implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC’s existing rules governing credit ratings.”
  • June 9: Bloomberg reports the SEC may recommend recommend that ratings agencies be prohibited from advising investment banks on how to earn top rankings for asset- backed securities
  • June 14: Reports emerge that the SEC is considering civil fraud charges against S&P and Moody’s in the run up to the financial crisis.

But Standard and Poors was not cowed by the SEC’s sudden rash of action. On July 14 they raised the threat of a downgrade to 50% within the next 90 days.

And now they were very explicit about what they were looking for in exchange for a AAA rating. They wanted a number….which just happened to be the magic $4 trillion number:

If Congress and the Administration reach an agreement of about $4 trillion, and if we to conclude that such an agreement would be enacted and maintained throughout the decade, we could, other things unchanged, affirm the ‘AAA’ long-term rating and A-1+ short-term ratings on the U.S.

Incredibly, S&P’s Devan Sharma told Congress this week that that S&P had been “misquoted” regarding the $4 trillion figure and that it had been “inaccurately stated that the company was calling for that specific threshold.” I really don’t know any other way you could read it. He also accused the administration of “meddling in the ratings process,” a charge quickly trumpeted by Republicans on the committee.

Politico reported that administration officials were “shocked by the move,” suggesting that it did not seem to square with prior S&P reports (duh).

But S&P wasn’t done. On July 21: David Beers met with Congressional Republicans in a closed door meeting to brief them on a potential downgrade of US debt.

And on that same day, the House Financial Services Committee approved the bill to remove the Dodd-Frank provisions that subject credit ratings agencies to expert liability. It passed 31-19 “over the opposition of the senior Democrat on the panel,” devolving into a clear partisan effort.

Then on Tuesday of this week [July 26], the SEC unanimously approved a plan to erase references to credit ratings from certain rulebooks. They also adopted alternatives to the credit ratings — a blow to the CRA’s [credit rating agencies; e.g., S&P] entire business model.

That last body blow by the SEC happened on July 26. As Yves Smith would say, “Quelle Surprise!” This sort of sleaziness (not to mention outright fraud) is nothing new for the rating agencies. Currently, Connecticut is suing the agencies for rating its municipal bonds as less credit worthy than they actually are, increasing the cost to taxpayers–even though these bonds are a much lower risk than the highest rated corporate bonds (italics mine):

“We are holding the credit rating agencies accountable for a secret Wall Street tax on Main Street — millions of dollars illegally exacted from Connecticut taxpayers,” Blumenthal said. “Connecticut’s cities and school districts have been forced to spend millions of dollars, unconscionably and unnecessarily, on bond insurance premiums and higher interest rates as a result of deceptive and deflated credit ratings. Their debt was rated much lower than corporate debt despite their much lower risk of default and higher credit worthiness.

“Studies done by all three agencies themselves since 1999 show that public bonds default far less often than corporate bonds with similar, higher credit ratings. In fact, public bonds with low ratings have lower default rates than the highest rated corporate bonds. They have maintained the dual standard to financially benefit bond insurers, investors and ultimately themselves.

“This rating charade created a Wall Street shell game constructed by the ratings agencies for the benefit of the bond insurers — which enabled the bond insurers to profit from unnecessary premiums and interest paid by taxpayers. All three rating agencies admit and acknowledge — in their own studies conducted as long as nine years ago — that states and cities have virtually zero risk of defaulting on loans. Despite their own conclusions, the credit rating agencies purposely concocted a dual rating system, enabling them to impose lower ratings on municipalities than corporations that are far more likely to default….

Expenses paid by taxpayers for bond insurance and higher interest rates would have been unnecessary if the rating agencies fairly and honesty rated public bonds — based on the likelihood public bond issuers would pay back their bonds on time.

One central reason for the continued underrating was the coordinated efforts of the bond insurers to convince Moody’s to maintain the dual rating system. In 2006, as Moody’s considered changing its practices and rate public debt on the same scale as corporate debt, an Ambac executive wrote “did we know this was coming — at first blush this looks pretty serious to me…This is cutting at the heart of our industry…While we in the industry might agree with the default/loss conclusion (this is in part the basis of our success and ability to leverage as high as we are), to lay it out there like this could be very detrimental.”

One of the costs that taxpayers had to buy was buying bond insurance. Suppose you’re trying to sell debt but you’re given a low rating. You can go to a private insurer and buy insurance, and your debt is now assigned the rating of the insurer, usually AAA. One problem though–not only was most debt rock solid, but the insurers themselves didn’t have AAA ratings according to S&P (pdf; p. 11, #38).

And the government is irresponsible?

Look, I won’t rule out that S&P is stupid incompetent and ideologically blinkered . But they routinely commit fraud (and I’m certain if other states investigated, they would find the same thing). They are attempting to bully the American people to prevent an investigation into the role in the housing crisis, as well as preserve their business model by forestalling the new SEC regulations.

This is what frauds do. And by issuing these ratings, they can now claim, as they have already done before, that any investigations are ‘revenge.’ Conservatives, who receive lots of contributions from them and who perceive another political opportunity, will fire up the Mighty Wurlitzer, once again demonstrating that they are more enamored of their own power and prerogative than the rule of law and the welfare of the Republic. Fox News and other rightwing outlets will shriek about government interference, casting doubt, creating a ‘controversy’ where there should be none. It will be one more example why no nation can endure half-Fox news and half free.

This is why, despite the urgings of the Great Conciliator, you have to look back, not just forward. Because if you don’t, they just do yet another awful thing.

Standing up to the rating agencies is one of the few good things the Obama Administration has executed competently. But will he fight for it? And will we make him?

Related: Matt Stoller has several other examples of the rating agencies’ awful behavior.

Comments

  1. #1 Nick
    August 8, 2011

    Oh, dear. Shoot the messenger.

    S&P its just an opinion. You haven’t paid them any money so you’re not a customer. Neither is the US government because it hasn’t asked for a rating.

    Purchasers of bonds who pay S&P are the customers.

    The problem is you don’t like S&P’s answer.

    It’s very simple, you are going to be down graded if you spend 40% more than you tax.

    You can either cut spending and pay back debt. If the US does, it rating will go back up.

    You can increase taxation. By a huge amount. However, that’s unlikely to get your rating back, because that results in lower tax revenues. It’s tax revenues that pay the debt off.

    All S&P care about, because it’s the question they are asked, is are bond investors going to get their cash back. They aren’t asked other questions.

    I would say their answer is pretty accurate.

  2. #2 Roman
    August 8, 2011

    There is a simple way solve the rating problem: government regulators should stop using them as a benchmark. If the use of ratings is purely voluntary, they will be only used if considered reliable.

  3. #3 Roman
    August 8, 2011

    As for now, the US T-bill yield hasn’t shot up. So WHAT IS THE WHOLE ROW ABOUT? I have the impression that it’s mostly about politics, not finance.

  4. #4 Wow
    August 8, 2011

    roman, if the USA is given a AAA rating despite the USA being so partisan one half is willing to scupper the US economy to get their way, then the S&P rating is not reliable.

    How reliable is the US economy?

    As reliable as Teabaggers will let it be.

    I’m surprised that it wasn’t given an F, TBH.

  5. #5 Lynxreign
    August 8, 2011

    Nick @1

    Really? You think there’s any risk at all that bond holders won’t get their money back? Point to a time where it hasn’t happened. Point to when there’s been a delay.

    It’s very simple, you are going to be down graded if you spend 40% more than you tax.

    All S&P care about, because it’s the question they are asked, is are bond investors going to get their cash back. They aren’t asked other questions

    You can’t even be consistant in a single post.

    As for the other nonsense in your post, you’d do well to read the other posts on this blog, follow the links provided and educate yourself about economics.

  6. #6 Roman
    August 8, 2011

    “I’m surprised that it wasn’t given an F, TBH.”

    There is no F rating. Given the current yields of US treasuries, anything lower than AA would be out of the blue. Let’s not get carried away.

  7. #7 dean
    August 8, 2011

    S&P is accurate? That explains why they performed so poorly in identifying monetary problems in the past. It would also explain the $2 trillion dollar error in their first analysis here.
    “You can increase taxation. By a huge amount. However, that’s unlikely to get your rating back, because that results in lower tax revenues. It’s tax revenues that pay the debt off.”

    Letting all of the tax cuts President Bush moved in, and (for some reason) President Obama let continue, would be an excellent start.

  8. #8 Wow
    August 8, 2011

    “S&P is accurate?”

    I think this indicates a problem people here are having.

    Your credit rating is about how confident people are that your money is worth what it is printed at.

    If the money markets are not confident, then your rating drops.

    It’s the same when you don’t have a credit history: they don’t know whether you can or not and will give you a bad rating. NOT because they know what your defaulting rate is and that you are a bad risk, but that they don’t know and therefore cannot be confident you’re a good risk.

    PS roman, look up “humour” in the dictionary.

  9. #9 Roman
    August 8, 2011

    Wow, look up the post-downgrade T-bill yields…

  10. #10 Wow
    August 8, 2011

    And this has WHAT do to with the risk of US currencies downgrading from “Absolutely rock solid” to “Really Solid” how?

  11. #11 Troublesome Frog
    August 8, 2011

    You can increase taxation. By a huge amount. However, that’s unlikely to get your rating back, because that results in lower tax revenues.

    Until people stop believing this sort of nonsense, we’re never going to be able to solve our problems. Except in pathological cases, raising taxes raises revenue. We’re about as far from being one of those pathological cases as we could possibly be.

  12. #12 Windchasers
    August 8, 2011

    The US debt rating should drop. We’ve now got one party in office who would be quite happy to see the US default. There is a non-negligible risk we’ll see more of the same debt ceiling stupidity in the future, and possibly with worse consequences.

  13. #13 Eric Lund
    August 8, 2011

    The issue with the S&P downgrade is not that there was a downgrade, it is that the rater in question is incompetent or malicious (these two choices are not mutually exclusive). There are no material facts regarding the state of the US balance sheet that were not evident six months ago, just some political posturing in which the Republicans reiterated their long-standing opposition to any form of tax increase. A competent, apolitical ratings agency would have done the downgrade at least a few months ago. S&P, however, is one of the agencies that was handing out AAA ratings to securities based on mortgages that any reasonable observer should have known would not be repaid other than by refinancing or selling the property (i.e., the Greater Fool Theory). That S&P waited until Friday to announce a downgrade–after the debt ceiling political crisis–gives the appearance that they are playing political games. A ratings organization, like Caesar’s wife, must be beyond repute.

  14. #14 Roman
    August 8, 2011

    @Wow

    “And this has WHAT do to with the risk of US currencies downgrading from “Absolutely rock solid” to “Really Solid” how?”

    I’m jsut saying that S&P haven’t really moved the markets with their rating. I think they kind of reflect the prevailing market sentiment.

    @Eric Lund

    6 months ago we didn’t expect the debt ceiling to become a hot political issue. The perception is that the political risk of US debt has increased from “nil” to “non-negligible”. This became apparent over the last few weeks, hence the downgrade.

    S&P was in a “damned if they do, damned if they don’t” situation with this rating, really.

  15. #15 dean
    August 8, 2011

    The debt ceiling only became a hot political issue because extremists lied and made it one in order to take attention off their purposeful lack of intelligent action. The perception of the that the political risk increased is entirely due to those same extremists – witness the times they put forward requests. the president accepted, and they backed away.

    S&P fell into line with the downgrade just as it was hoped they would. If they make their decisions based on the lies and false elevation of importance of the debt ceiling we’ve seen the past months, they no longer deserve to be taken seriously or be seen as an impartial set of judges. In no way were they “damned if they do, damned if they don’t” as you put it.

  16. #16 Roman
    August 8, 2011

    @dean

    “The debt ceiling only became a hot political issue because extremists lied and made it one in order to take attention off their purposeful lack of intelligent action.”

    On this side of the Atlantic, we see it as, guess what, POLITICAL RISK.

    “The perception of the that the political risk increased is entirely due to those same extremists – witness the times they put forward requests. the president accepted, and they backed away.”

    So your claim is that they created political risk in order to create the perception of the increase of political risk? That’s damn clever of them.

    “If they make their decisions based on the lies and false elevation of importance of the debt ceiling ”

    Is political risk a meaningless formality, or is it a real brake applied to government spending?

  17. #17 Wow
    August 9, 2011

    “I’m jsut saying that S&P haven’t really moved the markets with their rating.”

    So why all the posting?

    If it’s not changing the market and this means something significant, then why do you want to ignore the S&P?

    You seem to want to have your cake and eat it too.

  18. #18 Roman
    August 9, 2011

    @Wow

    Sorry, can you clearly state your point about S&P? Like: what have they done right, what have they done wrong, what they should have done and why.

  19. #19 Wow
    August 9, 2011

    I’m asking you why, if the downrating is having no effect, why did you say:

    2

    There is a simple way solve the rating problem: government regulators should stop using them as a benchmark. If the use of ratings is purely voluntary, they will be only used if considered reliable.

    Posted by: Roman | August 8, 2011 10:18 AM

    ?

    If the downgrade isn’t affecting the economy, why did you want that?

    Just a knee-jerk hate-on?

  20. #20 Roman
    August 9, 2011

    @Wow

    “If the downgrade isn’t affecting the economy, why did you want that?”

    Because the US credit rating should reflect the US credit quality. Keeping it at AAA when it should be AA+ would not be fair to countries which have AA+.

    And the fact that the downgrade didn’t move the markets is that the markets have already decided that the US is not AAA. The US really tarnished its image in the markets with this whole political row over the debt ceiling and cutting the deficit.

    “Just a knee-jerk hate-on?”

    This is something I can’t understand — why do you take this whole issue so emotionally? It’s not about hate or love. It’s just about money.

    What’s next, calling S&P “anti-American”?

  21. #21 Troublesome Frog
    August 9, 2011

    Roman:

    And the fact that the downgrade didn’t move the markets is that the markets have already decided that the US is not AAA. The US really tarnished its image in the markets with this whole political row over the debt ceiling and cutting the deficit.

    I wouldn’t go that far. In order for the market to have priced in a drop from AAA to AA+, you’d have to have seen a decline in bond prices at some point. That hasn’t happened. The more likely explanation is that the markets simply don’t care what S&P has to say on this issue.

    That makes good sense for a few reasons:

    1) As discussed above, the bond ratings agencies don’t have the best reputation right now.
    2) Unlike the debt of obscure private companies, people generally know what they’re getting with US debt. There’s no reason to think that S&P has any insight that the rest of us don’t.
    3) Ratings agencies in general don’t do a very good job of rating sovereign debt. It has been shown repeatedly that they consistently grade governments much harder than private companies. Looking at downgrades versus actual yields shows a consistent pattern of grading on a public vs private curve.

    Basically, this type of thing seems to be (and probably should be) met with a collective eye roll. S&P wants attention. They have it. Yay. Let’s get back to what we were doing so they don’t get the impression that they matter the way they used to.

    That’s not to say that our government hasn’t behaved shamefully. The fact that we can even have this conversation with a straight face is evidence that the Republican party has harmed our credibility. But that doesn’t make S&P any more credible.

  22. #22 Neil Craig
    August 9, 2011

    “excellent posts debunking Standard & Poor’s recent downgrade of U.S. debt”

    “Debunk” seems to be the latest PV term. It claims the disproving of a fact without actually having to produce any actual evidence. In this case it is particularly obviously egregious since the downgrade actually happened.

    Imagine, according to the argument given here, what grading they would have given if S&P wasn’t under USD jurisdiction.

  23. #23 Roman
    August 9, 2011

    @Troublesome Frog

    “I wouldn’t go that far. In order for the market to have priced in a drop from AAA to AA+, you’d have to have seen a decline in bond prices at some point.”

    Not necessarily. The decline of the US debt quality happened simultaneously with the decline of the quality of other debt. We live in a world in which NOTHING is AAA anymore. Get used to it. That’s the major change after the credit crunch (or, maybe, it’s a return to sanity — why should anything be “risk free”?).

    The US is saved, paradoxically, by the sheer size of their debt. There is a pool of capital out there in the wild, which has to go somewhere. If you sell trillions of US bonds, what are you going to do with the dollars you’ll receive for them? stuff them up the chimney? When US goes down, it increases the risk elswhere, and T-bills end up being the safest of the unsafe assets after all.

  24. #24 Troublesome Frog
    August 9, 2011

    Roman:

    Not necessarily. The decline of the US debt quality happened simultaneously with the decline of the quality of other debt.

    All other debt? All of these narratives can be tested by looking at the relevant spreads over time. How do we compare over time with other AAA countries? As I see it, there are only two logically consistent possibilities:

    1) The quality of all other debt declined equally, making it tough to tell what the market really thinks because we lack a frame of reference. In that case, a “good” bond rating agency would be downgrading AAA countries left and right, assuming that AAA is an “absolute” rating.
    2) The quality of US debt has declined over time relative to the quality of other AAA debt. This justifies downgrading the US but nobody else. If true, this should be reflected in the spreads between US debt and other AAA debt. I haven’t done a deep analysis, but this trend is not apparent to me.

    The only way I see the S&P rating making sense is if they know something that the markets don’t. That’s certainly not unheard of, but I don’t think it likely in this case. There really isn’t much more to US treasuries than meets the eye, and S&P just doesn’t have much credibility on the subject.

  25. thanks useful entry

  26. #26 Wow
    August 11, 2011

    “The only way I see the S&P rating making sense is if they know something that the markets don’t.”

    Or if they’re making decisions that the market you’re looking at doesn’t take into account.

    The sale of Yahoo to Microsoft was mandated by a market that doesn’t look at the long term profit but instead cares only about the next quarter.

    The CEO knew that more money would be made by Yahoo continuing to exist as a separate company but over years, whilst many big investors wanted the immediate payout from Microsoft, even if that means that there would be no Yahoo or value in the shares a year down the line: they were intending to sell them to a sucker well before then.