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S&P should avoid political predictions

The credit ratings firm, which warned that it might downgrade its assessment of U.S. government debt because politics could hinder efforts to control the deficit, lacks credibility in its forecasts.

April 22, 2011|Michael Hiltzik

The credit ratings firm Standard & Poor's doesn't exactly have a stellar record in predicting the future. It missed the flaws in Orange County's investment portfolio that led to the county's 1994 bankruptcy. It missed the cancer eating away at Enron. It missed the mortgage meltdown.

But good news: It's now getting into political prognostication.

Last week S&P issued a blockbuster report on the credit prospects of the U.S. government. While maintaining the government at its highest rating, AAA, the firm revised its "outlook" on the government's future creditworthiness to "negative." That signifies there's a 1 in 3 chance that S&P will downgrade its ratings on government debt sometime in the next two years. S&P said it's not convinced that Congress and the White House will get their act together to bring the federal deficit under control by 2013.

The U.S. downgraded, like a homeowner bailing on his mortgage? The prospect sent the stock and bond markets skidding — for a spell. White House economic advisor Austan Goolsbee stood in front of CNBC's cameras to say S&P didn't know what it was talking about. GOP deficit hawks in Congress, on the other hand, proclaimed that S&P had "sent a wake-up call to those in Washington asking Congress to blindly increase the debt limit," to quote House Majority Leader Eric Cantor of Virginia.

What possessed S&P to inject itself into the biggest political controversy of the moment isn't clear. Perhaps the firm wants to look relevant again, after abandoning its professional responsibilities in the run-up to the financial crisis of 2008.

Possibly it's looking to hang out its shingle as political consultantship, since its old business of rating fixed-income investments isn't what it used to be. Possibly its analysts genuinely wish to communicate a warning about the nation's fiscal path. The important question is whether S&P told us anything we didn't know, or did it just muddy the debate over the deficit?

The last time the government faced the threat of a downgrade was in 1996, when Moody's Investors Service placed the government on credit watch because Republicans in Congress had balked, temporarily, at raising the federal debt limit. That's an eventuality that does indeed raise the prospect of default, because reaching that ceiling means the government cannot pay its debts.

Interestingly, the government faces the same situation now, with some GOP members of Congress threatening to block an increase in the debt limit (as Cantor hinted). Yet, oddly, S&P said it wasn't at all concerned about that. "We do not expect the government to default" because of a congressional rejection of the increased debt limit, it said.

That only makes S&P's reasoning murkier. Short of a blockade on the debt limit, there is virtually no way the U.S. government can default on its debt — as a sovereign nation, if worst comes to worst it can simply print sufficient greenbacks to pay its bills. In other words, the firm was basing its judgment strictly on today's political situation.

Before we get into why that's a peculiarly unwise step for a financial analysis firm to take, let's detour to the issue of whether Standard & Poor's has the credibility to speak out about anything just now.

Consider S&P's role in the financial meltdown, the recovery from which has, of course, necessitated much of our current deficit spending — including deficit-financed bank bailouts, deficit-financed unemployment relief and deficit-financed economic stimulus.

Standard & Poor's is one of three credit rating companies (the others were Moody's and Fitch) hired by the panderers of risky mortgage securities and derivatives to endow these soiled wares with glossy triple-A ratings, which the sellers coveted to quell the doubts of investors.

But S&P and the other firms were hopelessly conflicted: Their fees were based on the dollar values of the securities issues they were hired to rate. That gave them an incentive to treat any flaws they might have perceived in the issues' creditworthiness with, shall we say, tolerance. Get a reputation for saying no to the guy paying your fees, and bing! Kiss your market share goodbye.

The rating firms' derelictions didn't only cost mortgage investors money. By allowing banks and their regulators to be complacent about the quality of the assets on the banks' books, the credit agencies helped to impair the health of the entire financial system.

The bipartisan Financial Crisis Inquiry Commission concluded in its report issued in December that "the failures of credit rating agencies were essential cogs in the wheel of financial destruction." This judgment was shared by the Democratic majority and Republican minority on the panel. (As for Orange County and Enron, S&P settled a lawsuit filed by the county for chump change in 1999, and maintained that it overestimated Enron's credit health because it was misled by the company's brass.)

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