photo by Funky Tee

I was tied up with other matters this weekend, so couldn’t offer a take on S&P’s downgrade decision. Jane has done most of the spade work here. But I wanted to make a few points.

First of all, if the rating agency’s entire argument was that the political system showed itself to be “less stable, less effective, and less predictable” during the debt limit debate, and that this failure of policymaking and institutional capability increases the chances of default, I don’t have much to argue about that. But, there’s a policy response for that. S&P could do exactly what Moody’s did and call for the debt limit to be extinguished, on the grounds that the legislative branch shouldn’t get to vote twice on funding, once when they appropriate it and another time when they decide whether or not the bill should be paid. If they really wanted to exert some influence on behalf of bondholders, they could have said that they would downgrade US debt further if the debt limit isn’t abolished within 90 days. Since the brinksmanship over the debt limit constitutes the biggest – perhaps the only – threat to paying off US sovereign debt, then the appropriate action for entities judging creditworthiness is to ask that the country in question eliminate the arcane and also dangerous practice.

But that’s not S&P’s only rationale. They somehow think it’s appropriate to pick a random deficit reduction target – in this case, $4 trillion – and hold a sovereign nation responsible for reaching it by threatening their borrowing costs. This is absolute madness that goes light years beyond their core analytical function. It shows in the fact that the number has no special significance from a deficit reduction standpoint. It also shows in the fact that they are so statistically challenged by this new function that they made a $2 trillion calculation error, fully half of the arbitrary $4 trillion in deficit reduction they are demanding!

This all only makes sense if you view S&P as a malign political actor, as they have been for some time. Matt Stoller revives an example I hadn’t heard before:

In the early 2000s, several states attempted to rein in an increasingly obvious predatory mortgage lending wave. These laws, pushed by consumer advocates, would have threatened the highly profitable mortgage securitization pipeline.

S&P used its power to destroy this threat. Josh Rosner and Gretchen Morgenson told the story in Reckless Endangerment.


Standard & Poor’s was the most aggressive of the three agencies, however. And on January 16, 2003, four days after the Georgia General Assembly convened, it dropped a bombshell. Because of the state’s new Fair Lending Act, S&P said that it would no longer allow mortgage loans originated in Georgia to be placed in mortgage securities that it rated. Moody’s and Fitch soon followed with similar warnings.

It was a critical blow. S&P’s move meant Georgia lenders would have no access to the securitization money machine; they would either have to keep the loans they made on their own books, or sell them one by one to other institutions. In turn, they made it clear to the public that there would be fewer mortgages funded, dashing “the dream” of homeownership.

Standard & Poor’s said it was taking action because the new law created liability for any institution that participated in a securitization containing a loan that might be considered predatory. If a Wall Street firm purchased loans that ran afoul of the law and placed them in a mortgage pool, the firm could be liable under the law. Ditto for investors who bought into the pools.

“Transaction parties in securitizations, including depositors, issuers and servicers, might all be subject to penalties for violations under the Georgia Fair Lending Act,” S&P’s press release explained.

It ended with a warning: “Standard & Poor’s will continue to monitor this and other pending predatory lending legislation.” In other words, any states that might have been considering strengthening their predatory lending laws as Georgia did should beware.

You need to know just how important the wanton destruction of Georgia’s Fair Lending Act was to the current state of affairs – the financial crisis, 9% unemployment, all of it. This story is well-told in Michael W. Hudson’s The Monster as well. Georgia, and any state that dared model their anti-predatory lending practices, was essentially overruled by Wall Street, with S&P holding the whip. S&P was getting paid lots of money by bankers to rubber-stamp mortgage backed securities and they liked that arrangement just fine. So they basically got a state to throw out their own rules stopping mortgage brokers from ripping off their constituents because that didn’t meet with their bottom line. This word went out across the land – there will be no regulation of the mortgage market, now or forever. And that held until the bubble popped.

It’s not much different from S&P acting like the IMF and picking a random target – the exact same target that would result from just letting the Bush tax cuts expire, which if the country is as politically gridlocked as S&P’s analysis would suggest, is fated to happen, right? – or they’ll do whatever is in their power to extract a consequence.

To believe that S&P is doing a straight, dispassionate analysis of the nation’s fiscal situation and creditworthiness is to overlook that they have a terrible reputation and they aren’t even particularly good at predicting sovereign debt defaults. But dispassionate analysis is not their goal. This is.

The downgrade of the United States government’s credit rating by Standard & Poor’s is almost sure to increase pressure on a new Congressional “supercommittee” to mute ideological disagreements and recommend a package of deficit-reduction measures far exceeding its original goal of at least $1.5 trillion, lawmakers said Sunday.

Even before the panel is appointed, its mission is expanding. Its role is not just to cut the annual budget deficit and slow the explosive growth of federal debt but also to appease the markets and help restore the United States’ top credit rating of AAA. Otherwise, taxpayers may eventually have to pay more in interest for every dollar borrowed by the Treasury.

Taxpayers are currently paying the lowest rates for borrowing in decades (and they went down 1/2 a point in the last week, so even if they go up that much today, we will be effectively back where we started), and JPMorgan said last week the downgrade would have “no major implications for borrowing costs.” So that last line is entirely bullshit. S&P, while claiming to be agnostic about where the $4 trillion in deficit reduction must come from, said that cutting entitlement spending is “key to long-term fiscal sustainability.”

Already the usual suspects are jumping on this. The President’s statement highlights that the threat of a downgrade is why he pushed for a grand bargain. John Kerry, while producing a nice bon mot (“the Tea Party downgrade”), said the nation should get right to work “putting a plan on the table, $4 trillion plus, if necessary.”

When you see S&P not as some dispassionate political commentator but more akin to a corporate lobbyist things come into focus. In a sane world, we’d be raiding the Standard and Poor’s offices searching for evidence of their using their power and influence for a political result. Like they just did in Milan.

UPDATE: So far today, the benchmark 10-year Treasury yield HAS DROPPED, with fears of a weakened economy. Those crazy politicians have cost us negative-10 billion dollars!

David Beers of S&P has no regrets. I’ll bet he doesn’t.

David Dayen

David Dayen