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Monday, August 8, 2011

Standard & Very, Very Poor


Over the weekend, and into today, there has been much sound and fury about Standard and Poor's downgrade of the United States' credit rating to AA.  Unfortunately for S&P (or fortunately for the rest of us), it turns out that it is signifying nothing.  It is now left to the rest of us to wonder: what is happening here, what does it mean for us, and what does it mean for S&P?

What is happening here seems to be, first off, that S&P has made some serious errors.  Earth-shattering errors, the kind that if we're lucky they might never recover from.  The downgrade was based on a number of factors, but one of the main ones was that the amount of deficit reduction was insufficient to slow what they saw as a rapid climb in debt-to-GDP ratios.  As it happens, though, their projection was based on the wrong baseline metric.  This equates to about a $2 trillion dollar discrepancy, otherwise known as "antihistamine money", since it is not to be sneezed at.
Note how much quicker the climb is under the original, flawed estimate.
But really, that's just the tip of the iceberg.  Ezra Klein does a better job than I ever could on this one, pointing out all the contradictions in S&P's report.  For example: S&P claimed that allowing the Bush tax cuts to expire would allow for an upgrade in the outlook of our credit rating.  Yet, their revised estimates, after fixing the $2t mistake, account for significantly more savings than the Bush cuts would have.  Surprising no one, though, S&P kept their downgrade in place.  At least they're committed to something (i.e. being terrible at their jobs).

It gets even more damning, too, as Klein points out:
Similarly, they have previously explained that while a $4 trillion deal could have saved our credit rating, a $2.4 trillion deal — which is what we got — was insufficient to stabilize the debt. But since their original calculations misplaced $2 trillion, the deal and the correction should have added $2.4 trillion + $2 trillion to our bottom line. That, again, is more than $4 trillion.
That S&P - responsible in their own way for the subprime mortgage crisis anyway because of their frightening eagerness to rate crap mortgages as AAA - would make this sort of mistake is not surprising.   It is also not surprising that they would double down on it.  After all, the downgrade really isn't about the economic ability of the United States to pay its debts.  That would be ridiculous.  It is more about the political ability to do so, which might be the only thing they got right in this whole thing.  Don't believe me?  Take it from them:
 More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
Amusingly, it might not actually matter.  Sure, stocks are dropping, but that started before the downgrade.  But demand for U.S. Treasury Bonds is as high as ever, and in fact bond prices ticked up slightly.   Interest rates, in turn, also dropped slightly.  Rather than abandon all faith in the safety of Treasury bonds, investors have reaffirmed that faith in spades.

It looks like the upshot of all this is that rather than lose faith in the United States, investors are losing faith in S&P instead - an idea echoed by none other than Warren Buffett.  Standard and Poor's probably had this coming as a result of their role in the financial crisis, of course.  I'm not going to shed any tears if they lose a little prestige.  But there really is no other obvious answer to what happened here: they downgraded themselves instead of the United States.

The funniest part is that their analysis of our political system isn't actually wrong.  A week ago, we were within hours of an outright default.  And it happened because a sizable portion of Congress is apparently made up of nine-year-olds, rather than those 25 and over as we all thought was required.  S&P's mistake - well, aside from the terrible math - was conflating that with everything else, and going too far in pursuit of making a political point.  And that's an error they might not ever recover from.

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