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S&P Threatens US Credit Downgrade

Standard & Poor’s, one of the three leading credit rating agencies, has has warned the US on the rating of its government debt.

S&P is concerned that Democrats and Republicans will not be able to agree a plan to reduce the growing US deficit.

The agency has downgraded its outlook from stable to negative, increasing the likelihood that the rating could be cut within the next two years.

The surprise move sent US and European stocks lower. The S&P 500 fell the most in a month, and the US dollar dropped against the euro and Swiss franc. Oil was also sharply lower.

The Dow is down 2% today on the news. Incidentally, this is not the first US credit downgrade threat that I recall; Moody’s threatened this in March 2010. The difference is that we’re in the throes of deficit fever now.

It seems like a rather convenient announcement, no? We’re right at the start of a discussion on the federal budget, and here comes S&P, which derives most of its revenue from the financial industry, warning that if the parties don’t come together on a deficit reduction scheme, they’ll downgrade debt. Of course, since the Republicans are more inflexible, Democrats will be persuaded by serious people to do the responsible thing and drop the revenue increases for the sake of protecting the AAA rating. And this would have wide-ranging effects: practically every other bond sold in this country that’s rated AAA, such as municipal bonds, would be downgraded as well.

I think at this point it’s prudent to call everyone’s attention to the Senate Permanent Subcommittee on Investigations report on the financial crisis, and its ample section on the rating agencies, and their complete failure to accurately rate mortgage bond products that were obviously unstable. In fact, Standard & Poor’s is specifically targeted in that report. Why rating agencies still exist is a pertinent question, given their contribution to the near-ruination of the global economy. In particular, the report hones in on the inaccurate models of the rating agencies:

The conflict of interest problem was not the only reason that Moody’s and S&P issued inaccurate RMBS and CDO credit ratings. Another problem was that the credit rating models they used were flawed. Over time, from 2004 to 2006, S&P and Moody’s revised their rating models, but never enough to produce accurate forecasts of the coming wave of mortgage delinquencies and defaults. Key problems included inadequate performance data for the higher risk mortgages flooding the mortgage markets and inadequate correlation factors.

In addition, the companies failed to provide their ratings personnel with clear, consistent, and comprehensive criteria to evaluate complex structured finance deals. The absence of effective criteria was particularly problematic, because the ratings models did not conclusively determine the ratings for particular transactions. Instead, modeling results could be altered by the subjective judgment of analysts and their supervisors. This subjective factor, while unavoidable due to the complexity and novelty of the transactions being rated, rendered the process vulnerable to improper influence and inflated ratings.

Why, exactly, should be believe that they have remedied these problems, especially considering that the internal culture at these companies, according to observers inside them, hasn’t changed a bit?

But instead of laughing this off, the stock market has reacted sharply negatively. It’s almost as if the whole game is rigged:

If I were cynical, I would suggest this is all part of the grand plan to sustain the wealth transfer of the last few decades. Now that most everything has been looted, it’s time for austerity for the have-nots. Pensions need to be slashed! Social Security is too expensive!

But don’t you screw with the tax cuts or the military. And don’t you dare ask S&P who pays their bills. They are just offering 1st Amendment protected speech!

It’s all a big game, and you don’t get to suit up and play.

Felix Salmon thinks this is more of a threat than a realistic outcome, because so many other sovereign credit ratings would have to be rethought. But it’s a threat in service to the drive toward austerity. And it comes right at the top of the coming debate. There are an awful lot of coincidences here.

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David Dayen

David Dayen