A Little Finance CSI: What Happened with Standard & Poor’s

When bad things happen, you can always count on politicians to cover their butts and point fingers.  Sure enough, within hours of S&P’s downgrade of the United States from AAA to AA+, with a further downgrade more than possible, they warned, the suits were in full spin.  I’m not going to waste your time or insult your intelligence by stating the obvious as to who was making accusations, or which networks carried their water; let’s just say it was the usual perps.  But it is important to understand just what happened, and why.

I went to the source, in this case S&P’s website.  There, I found a discussion about the downgrade by S&P’s Sovereign Analysts, Dave Beers and John Chambers, and the full report about the downgrade.

First, the real quote of interest from the report:

“We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.”

That’s Standard & Poor’s telling the government to stop whining and get serious about cutting spending.

 In the discussion by S&P analysts, Mr. Beers noted that the rating changed from ‘AAA stable’ to ‘AAA negative’ back in April, meaning that S&P was warning that the rating could change more than three months before they actually made the downgrade, and the need at that time to create a consensus to address the trend in government debt.  Mr. Beers’ quote is as follows:

 “We were watching very carefully the debate about fiscal policy issues, and most importantly the effort to create a consensus around a fiscal consolidation that would deal with the trend increase in government debt over the medium term.”   

 Mr. Beers said that in April they estimated a 1-in-3 chance of a downgrade, because there was doubt about creating a “fiscal consolidation” to reduce the debt.  By July there was strong reason to believe a consensus was unlikely, because the democrats, republicans, and the White House represented three very disparate camps of opinion.  When the deal was finally reached, S&P was not impressed.  Mr. Beers explains:

 “We looked at the agreement very carefully, and we concluded two things:  One was, reflecting on the whole debate this year, we concluded that the process itself was likely to continue to create uncertainty, about the resolve of the U.S.government to take decisive action on fiscal issues.”

“The other was simply our analysis of the agreement itself on the debt consolidation program, as we think it fell short in size and in its scope of what was needed to stabilize the debt in the medium term.”       

 That is, the problem was not the TEA Party refusal to go along with Obama’s demand for more spending, but the need for government to reach agreement on a plan to actually reduce the federal debt in the immediate future.  The blame therefore falls squarely on the Obama Administration and the no-cut oligarchs of both parties.    Standard & Poor’s repeated the warning in July with published downgrade warnings, specifically because no effective changes had been made in reducing debt.  Mr. Beers explained that the process involved “a number of decision points along the way”, so that no one event by itself drove the decision to downgrade; the problem was that the debt problem has still, even now, not been met with an effective plan.

Certain key factors are included in the rating of a Sovereign power, whether the U.S. or another country, which are called the ‘five pillars’.  John Chambers explained that the Real Economy, the Fiscal Stance (which is where Debt comes in), the External Position, the Monetary Policy, and the Political Centers.  The last pillar, Mr. Chambers explained looks at “the ability of political leaders to respond in a timely fashion to keep public finances in a sustainable footing.”   That is, credit-worthy nations use “good policy, consistently performed over time”.  By implication, the downgrade means that S&P doubts the U.S. policy regarding debt, international investment, and monetary policy is as effective now as it was in years past.    

The discussion continued to examine the “trajectory [of] debt consolidation”.  The simple explanation is that S&P did not consider the reduction of discretionary spending as agreed to be sufficient to materially reduce the debt, especially in the medium term.  Mr. Beers explains:

“Based upon our analysis, it won’t make a dent in the rising debt rate; it won’t be enough to prevent the rising trajectory, the debt to continue to rise over the medium term.”

The government deal did not cut deep enough, plain and simple.

Read the full report, but here are a few more key quotes from the report, just for clarity:

“Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending”

“In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.”

“We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand. As a result, our downside case scenario assumes relatively modest real trend GDP growth of 2.5% and inflation of near 1.5% annually going forward.”

Get over yourself, Mr. President.  Fix your mess or get out of the way and let the adults clean it up. 

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Posted by DJ Drummond on August 7, 2011.
Filed under Barack Obama, Big government, Economics, Federal Budget, Finance Reform.
DJ Drummond holds an MBA with a concentration in Accounting, and has worked in Finance/Credit for 13 years, with 17 years of Operations Management experience before that. He writes on political, religious, and cancer-related issues, with the occasional foray into satire and snark.

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