The credibility and integrity of S&P’s ratings action

By Felix Salmon
August 6, 2011
Treasury's official response to the S&P downgrade has arrived, and it makes for pretty depressing reading.

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Treasury’s official response to the S&P downgrade has arrived, and it makes for pretty depressing reading. Treasury’s taking a shoot-the-messenger approach: S&P made a mistake in its debt-sustainability calculations, they say, and therefore “the credibility and integrity of S&P’s ratings action” must be called into question.

Paul Krugman takes a similar tack:

it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really? …

This is an outrage — not because America is A-OK, but because these people are in no position to pass judgment.

Tyler Cowen warned about this:

As a simple rule of thumb, if at this point, in response to this news, a commentator attacks the ratings agencies for their previous mistakes and stupid, corrupt behavior, it’s a sign the commentator is trying to muddy the broader issues.

Yes, the ratings agencies were in large part responsible for the financial crisis. But their mistake there was having too many triple-A ratings. If you were looking for a sign that they’d learned their lessons, it would be that they were downgrading triple-A borrowers before crisis hit. And also that they didn’t place overmuch stock in official models. Whatever else S&P is doing here, it isn’t repeating its mistakes of the subprime bubble.

Treasury says that “the foundation for S&P’s initial judgment” was its debt-sustainability calculations, and that S&P only pivoted to a more political willingness-to-pay argument when the initial econometric argument fell apart. But this doesn’t make sense: S&P has no particular incentive to downgrade the US, and every incentive not to.

Instead, to understand S&P’s actions, you just need to understand two basic facts. The first is that S&P is not judging the quality of Treasury bonds as an investment. There’s a key difference between S&P, on the one hand, and Moody’s, on the other: when rating sovereigns, S&P doesn’t care about or look at the likely recovery in the event of default. If the US ever did default, investors would ultimately get back 100 cents on the dollar, interest included. Shorting Treasury bonds into that kind of a default wouldn’t make you much money. But it would still be a default — and S&P is trying to gauge the likelihood of such a thing happening.

Secondly, and more importantly, all sovereign defaults are political, not economic — especially defaults by countries which borrow exclusively in their own currency. S&P and Moody’s can look at all the econometric ratios they like, but ultimately sovereign ratings are always going to be a judgment as to the amount of political capital that a government is willing and able to spend in the service of its bonded obligations. If Treasury really believes that S&P based its judgment fundamentally on debt ratios and the like, it’s making a basic category error about what it is that sovereign raters actually do.

This part of the S&P statement isn’t some kind of hurried fallback justification for the downgrade, it has to be central to any decision to downgrade the US:

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…

The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge.

Any student of sovereign default knows that it is born of precisely the kind of failures of governance that we saw during the debt-ceiling debate. That is why the US cannot hold a triple-A rating from S&P: the chance of having a dysfunctional Congress in future is 100%, and a dysfunctional Congress, armed with a statutory debt ceiling, is an extremely dangerous thing, and very far from risk-free.

Yes, there’s a lot of fiscal math in the S&P statement. But at heart, any sovereign ratings decision is political, not economic: the economics is there to provide a veneer of empirical respectability to what is fundamentally a value judgment. We saw the values of Congress during the debt-ceiling debate, including various members of the House who said with genuine sincerity that they’d actually welcome a default. In that context, S&P’s judgment is hard to fault.

45 comments

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agree, this was always about “will they pay it back” and never about “can they”

Posted by ReformedBroker | Report as abusive

Felix this is wrong- “But this doesn’t make sense: S&P has no particular incentive to downgrade the US, and every incentive not to.”

Their biggest clients are the Primary Dealers. Those dealers have been heavily short in their Treasury positions for more than a year. This rally is KILLING them and destroying market liquidity.

Favors have been called in.

Posted by LeeAdler | Report as abusive

I think the math was irrelevant to the decision. I can’t see how someone blows a $2T hole in your calculation and you don’t rework your numbers overnight to be sure you’re right – unless the decision is qualitative, not quantitative.
More at: http://actuarialopinions.wordpress.com/2 011/08/06/thoughts-on-the-downgrade/

Posted by RZ0 | Report as abusive

“That is why the US cannot hold a triple-A rating from S&P: the chance of having a dysfunctional Congress in future is 100%, and a dysfunctional Congress, armed with a statutory debt ceiling, is an extremely dangerous thing, and very far from risk-free.”

PRECISELY. Now cue the GOP blaming the DEM and the DEM blaming the GOP in ever-decreasing circles until they disappear up their own….errrr…..well, y’know..

And before I hit the play button; Of course it was a political decision! Anyone who lives in an Emerging Market knows of old that decisions made by ratings agencies on sovereign debt are more political than mathematical. Big deal, welcome to the real world, USA, get used to the idea.

Posted by ottorock | Report as abusive

Psh, your post makes for depressing reading. S&P is making a political statement in keeping with the current climate of deficit hysteria, and I don’t know why anyone continues to give them the time of day.

Besides, Congress is the most dysfunctional it’s ever been, and they managed to get the ceiling raise passed. Is there really reason to believe it will get WORSE? I mean really, the debt ceiling debate bordered on the absurd. Why are you so fatalistic about future Congresses? Surely, surely they can do better.

Posted by loudnotes | Report as abusive

“If the US ever did default, investors would ultimately get back 100 cents on the dollar, interest included.”

That’s true as far as it goes… obviously since we issue in our own currency we can pass out as much of that as is required to pay off our debts… but will investors get their “value” back?

If I buy a 1 year treasury bond 12 months from now I will most assuredly get my money back with nominal interest… but if gold is at $2,000 Oil at $150, corn at $16 and so on did I really get paid back? People can claim that credit ratings don’t involve currency risk but that simply impossible. We can alway fill a hundred dump trucks with $100 dollar bills. The point is devaluing our currency by printing money is just default by another name.

Think about it… if our debt was pushing 1000% of GDP instead of 100% we could still pay it off if it was in dollars. The only real risk of default for the US, the UK, or Japan is through currency devalution rather than non payment.

Posted by y2kurtus | Report as abusive

There was a time when both parties in the US put America before their own interests: no more. The Tea Party have shown that fundamentalist Republicans – even after losing the last Presidential Election – do not accept the will of the people unless it is they themselves who are elected. Thanks to them, America is losing its image as a superpower. The downgrade is only a sign that the US has finally grasped what the rest of the world has known for some time: America needs to wake up to reality and change its path, or the whole world will be in a big mess.

Posted by FifthDecade | Report as abusive

I very much agree with your last two paragraphs, Felix, and wrote a post to that tone this morning.

@leeadler: people are already talking about government “revenge” against the ratings agencies: like now finally cracking down for their role in the crisis…

Posted by KidDynamite | Report as abusive

Indeed, when you study banking they teach you about the C’s of lending: character, capacity, etc… not many would argue the US’ capacity to pay back, but on the character part; the politicians demonstrated themselves to be wanting on that criteria over the past few weeks.

So I think markets will react like the US Fed did, i.e. pragmatism: not ostensibly change their view on the function of US govt securities as an investment/asset

Posted by ceebanker | Report as abusive

Forgot to add the link to my comment above (US Fed comments): http://www.centralbanknews.info/2011/08/ us-downgraded-to-aa-from-aaa-by.html

Posted by ceebanker | Report as abusive

OK, but then it should put blame firmly at the foot of the side that refused to compromise on anything, rather than this useless pox on both houses fiction. The downgrade is useful insofar only as it incentivizes necessary changes to dysfunctional governance. Even Tyler Cowen did that.

Posted by mw1 | Report as abusive

All of these arguments point out the fallacy of having a debt ceiling at all. What does it do besides give one side or the other an opportunity to hold the country at gun point? After all, the money has been appropriated, so it’s not like it’s an open window to go wild and spend everything in the Treasury. It’s already gone and spent – the raise in the debt ceiling is just to allow for borrowing to pay for it. The most practical and therefore least likely to be enacted solution is to eliminate it once and for all. In the meantime, as mw1 has said, let’s lay the blame where it rightly belongs. There was only one party in this fight prepared to hurl the country over the cliff. Let’s hope they understand the downgrade for what it is.

Posted by sportsbiz | Report as abusive

Just to point out: Tyler Cowen is not a ‘neutral’ agent either, as he is a chief water carrier for the Mercatus center — which, iirc, is funded by the Koch brothers.
So his attempt to discredit anyone criticizing S&P for having no methodology should also not be taken at face value. It may well be that the US deserves a lower rating, but I don’t see why we should take S&P’s decision to be any more meaningful than a decision based on a reading of bird entrails. Their downgrade is purely political — and for further proof of that, remember that their demand was a $4T spending cut, while there is no economic theory worth taking seriously that would recommend that course of action.

Posted by Foppe | Report as abusive

Obviously the Ratings Agencies are purely a “Political” entity. It was Corporate Politics that caused them to give AAA ratings on junk loans. And now that Congress has “called them on the Carpet” about those ratings, they’re giving “Pay Back” by downgrading the US Rating purely on Politics and “mistakenly??” Miscalculated the future dept. It’s all just “Politics”. S&P may have signed their “death warrant” with this.

Posted by jbhodge | Report as abusive

“including various members of the House who said with genuine sincerity that they’d actually welcome a default.”

Its pretty astonishing that this article can go on for around 600 or so words without ONCE pointing out that all of the ‘various members of the house’ were from a single political party – the GOP. Its not just that America’s political institutions are in bad shape Felix – its that the journalistic class is so utterly incapable of escaping the nauseating prism of ‘balance’ and finding new and inventive ways of blaming both sides equally for every crisis. I’ve had this from editors I’ve pitched to before – apparently reporting objective reality would hurt the fee-fees of Republicans, and would be too stridently partisan. As a result – the great mass of the American people have absolutely no way to objectively evaluate the political performance and policy platforms of their leaders, and nothing changes.

Put it another way – articles like this are just as big a part of the problem as the filibuster and Teabaggers.

Posted by DaraghMcDowell | Report as abusive

“including various members of the House who said with genuine sincerity that they’d actually welcome a default.”

Its pretty astonishing that this article can go on for around 600 or so words without ONCE pointing out that all of the ‘various members of the house’ were from a single political party – the GOP. Its not just that America’s political institutions are in bad shape Felix – its that the journalistic class is so utterly incapable of escaping the nauseating prism of ‘balance’ and finding new and inventive ways of blaming both sides equally for every crisis. I’ve had this from editors I’ve pitched to before – apparently reporting objective reality would hurt the fee-fees of Republicans, and would be too stridently partisan. As a result – the great mass of the American people have absolutely no way to objectively evaluate the political performance and policy platforms of their leaders, and nothing changes.

Put it another way – articles like this are just as big a part of the problem as the filibuster and Teabaggers.

Posted by DaraghMcDowell | Report as abusive

Very good analysis.

I think the only thing where S&P is to blame is that they did the downgrade only now. If any other country engaged in such an insame debt ceiling theatre, it would have been punished by the rating agencies months ago (and rightly so).

I found this leniency wrt to the biggest economy (which is increasingly being taken hostage by political nutters) rather disturbing.

Pauls argument is for once a little bit ridiculous. Where not talking about new, arcane and complex structured finance products but about sovereigns. That’s the core business of the RAs for decades. They know what they are doing.

It’s amazing how similar the political reactions to justified (but painful) decisions by the RAs are in Europe and the states.

Posted by OlafStorbeck | Report as abusive

According to your argument they should just hand out ratings based on the political stability of the sovereign. When you put it like that your argument sounds pretty stupid. This same kind of blind faith thinking is what got these guys their un-deserved legitmacy – which is horsecrap. How can a 2T difference of opinion be trivial? You just want the debt ceiling abolished and you’re using this as an argument in favor of that.

Posted by Woltmann | Report as abusive

Here’s Matt Stoller pointing out that S&P “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 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.”

http://www.nakedcapitalism.com/2011/08/m att-stoller-standard-poor’s-predatory- policy-agenda.html

Posted by Foppe | Report as abusive

Felix, can you do the legwork and analyze how many of S&P’s previous decisions on other sovereign downgrades were dressed up as “political process” arguments vs. more pure economic threshold arguments?
That the US isn’t in the same league as we were 10 years ago with capacity and willingness to pay our debts isn’t news, and it is a matter of time before all the ratings agencies formalize that. But to disguise it as a political process argument is interesting, when even in this debate, every politician agreed that it was their intention to raise the debt ceiling, and many (even you I think) speculated whether the debate was all political theater with a foregone conclusion of raising the debt ceiling.

Posted by FDum | Report as abusive

Whilst I know that tiny little things like getting the facts right are not really important to alot of people but I think that if S&P really want to be taken seriously they should be able to get basic maths right.

Weird comment from Paul Krugman, given it was the US government followed much later by Basel committee that enshrined the rating agencies as the seers of credit risk.

Foppe, love the conspiracy theories, especially when spouted by people who think the NYT, Naked Capitalism and the idiot who wrote No Logo have no agenda. Still confusing Thailand and Taiwan are we?

Posted by Danny_Black | Report as abusive

“That’s true as far as it goes… obviously since we issue in our own currency we can pass out as much of that as is required to pay off our debts… but will investors get their “value” back?”

Currency is a shared fiction based on confidence, and such a move would severely damage confidence in the dollar. A certain amount of “monetization” can fly under the radar, but beyond a certain point a formal default becomes preferable. The bondholders won’t treat it any differently from a hyper-inflation scenario, and formal default does less damage to the real economy.

That said, bondholders don’t expect to get their value back. Shorter-term TIPS already trade with a negative coupon, and even 20-year TIPS have a coupon under 1%.

Remember also that the CPI tends to understate practical inflation, since the calculation insists that you save money when you buy a superior product (e.g. next generation electronics) for the same price. Yet ultimately a phone is a phone, and I’m paying more for telecommunications and computing than I was 20 years ago.

Posted by TFF | Report as abusive

Danny: it is impressive to see what lengths you go to in order to not have to engage with information. So now the NYT, Naked Capitalism and Naomi Klein are all conspiring together to make you doubt the holy words of S&P? Enjoy your little ad-hominem filled world.

Posted by Foppe | Report as abusive

There is a huge liquid market for treasuries. Unless you have no faith in the ability of markets to set prices, then you should be able to safely ignore what S&P says.

I’m baffled as to why Felix seems to think that rating agency grade on sovereigns matter so much. It shows a basic lack of economic understanding.

Posted by AASH | Report as abusive

The presentation on the 10-year budget outlook (with 4- % growth numbers??) had a credibility even lower than Colin Powell’s presentation on Iraq in the UN.

Still, many Americans believe the national debt is 65 % instead of over 100 %. What a joke.

It is time to stop the lies. Time to clean up.

Posted by FBreughel1 | Report as abusive

This post is a pretty cynical piece of analysis if taken literally, Felix. S&P waves its hands about having an economic rationale for its decision, but “economics is there to provide a veneer of empirical respectability to what is fundamentally a value judgment.”

What qualifies S&P to be uniquely suited to pass such judgments on sovereign debt if it’s not empirical analysis? I agree that US politics is majorly screwed up (especially because of the intransigence of the Tea Party caucus, but also because of the delusions of centrist deficit hawks) but value judgments are like a**holes — everyone’s got one.

If Felix accepts S&P’s method as acceptable, they can dispense with evidence and data altogether in the future, and say about sovereign debt: “It just doesn’t feel right” or “I got a good feeling about this one” when issuing AAA ratings.

My conclusion: Cowen is wrong and Krugman is right — again. And whatever other mistakes they’ve made, Treasury is right to complain about S&P’s bad faith.

Posted by lkonstan | Report as abusive

I completely agree.It’s a mistake to discuss numbers.
The problem lies in the reliability of the American politics.And if there is someone around that can affirm that everything,from the Government to the Congress,isn’t in a MESS,well,open the eyes,don’t be partisan or parochial.
We are in a tragic,dangerous mess.From a moral point of
view,US have failed to be the world leader (and unluckily
there is none).In God we Trust,in US a little bit LESS.

Posted by SteveP | Report as abusive

Yes, this isn’t about the deficit. It’s about the sizable number of politicians who see default as something desirable.

Posted by MyLord | Report as abusive

Felix, I like you and you are obviously a very smart guy. But I take issue with your dismissal of S&P’s critics for three reasons.

1. S&P is selling its judgement as a product. Potential consumers *should* question the veracity of that judgement in light of past mistakes. IF S&P helped cause this problem- why should we believe they know anything about how bad it is or magic targets that will fix it?

2. The MBS misrating was possibly *not* a mistake. The issuers of these securities had some market power over the rating agencies. There is more than a semantic difference between a bug and a feature.

3. When you are selling your judgement about anything financial or economic, you do not get to make 8% mistakes.

So, whether or not the us’s political problems keep them from being AAA is really beside the point. It may be true, but I don’t have to believe anybody who 1) has been very wrong in the past, 2) possibly because of corruption, 3) who also doesn’t follow the debate closely enough to make even a good show of doing the math.

Posted by http | Report as abusive

Where have all of the adults gone?

Felix Salmon’s convoluted reasoning, as well as that of S&P, is downright childish. The mere fact that the debt ceiling was a bargaining chip in the game of hardball politics does not imply that either party, Democrat or Republican, would ever allow a technical default of U.S. debt. The parties – including minority fringe elements of both (yes, even the maligned hard-bargaining Tea Party) – have proven and will again in coming months and years that they are NOT suicidal.

In the foreseeable future, risk of U.S. debt default = 0.

Posted by jca | Report as abusive

Felix! Given the utter corruption exhibited by S&P in the past with their RESPONSE to their rating errors in the bond mess how can you possibly argue that they are not playing the same game now? These guys have exhibited absolutely no sense of responsibility; their own employees hate them for their propensity to lie.

You are advancing a naive argument – that they are blameless because U.S. politics are actually dysfunctional. No, the correct answer is S&P is run by corrupt scum using dysfunctional U.S. politics to divert attention. Chicken/Egg semantics are irrelevant.

Posted by ARJTurgot2 | Report as abusive

Felix: You know more about this subject than I do, so please consider these questions from someone extremely skeptical about what you have written here, but an amateur when it comes to writing about the financial system. I would need a lot more information from you before I am prepared to swallow the argument in this post. To wit:

1. Compartmentalization: You have some theory of compartmentalization here that needs to be spelled out. From my reading, S & P’s performance on mortgage debt revealed a company with institutional integrity and domain competence very close to zero. I understand (meaning: I read Tyler Cowen’s post and your endorsement of it) that I am supposed to be dismissed as unsophisticated, a cover-up artist, or an agent of distraction for mentioning any of that in this context, but here’s what I don’t get… How is it that S & P was capable of a pathetic default in responsibility on mortgage debt, but the same company is now shrewd, reasoned, prudential, tough-minded and basically right about government debt? You must have some theory of corporate culture, or compartmentalization, that you are not articulating. I want to know what it is.

2. Lesson learning: You seem to be suggesting that an utterly incompetent, asleep at the switch, failed-in-the-clutch company has somehow learned its lessons and is now trying to get ahead of the next crisis. So I am curious: did you find evidence of this stock-taking and lesson-learning, some sober, coming-to-grips with massive institutional failure, in the testimony of the ratings agencies heads before Congress and the FCIC? I did not see any evidence of that. But maybe you did. Please advise.

3. I take your point that this a political assessment, and not really a by-the-numbers call on the economics of the debt. I certainly agree with that. But you seem to be saying (correct if I am wrong) that Standard & Poors made a bold, candid, clear-eyed and realistic political call by downgrading the U.S. I’m sorry but I cannot believe you. For a bold, candid, clear-eyed and realistic political judgment would not mince words about what has changed; it would say flat out, “The Republican party has changed. It is now willing to de-stabilize the system and introduce radical doubt about the willingness of the U.S. to make good on its promises. This is new. This is unprecedented. And it is this development that has brought us the point we are at now.” But nothing like that appears in the S & P opinion, which I have read. It goes all “both sides” on us. Why? If I believed your analysis, I would expect far tougher and more candid language than we actually see in the opinion.

Thanks for listening And as I said on Twitter, “I’ve never disagreed with @felixsalmon more.”

Posted by jayrosen | Report as abusive

With all due respect Mr Salmon, it is impossible to divorce the S&P role in the financial industry meltdown due to their incompetence and corruption in their ratings of mortgage securities with their downgrade of the US credit rating. It is at least partially due to their giving crap securities AAA ratings that the US has incurred the problems that have included the increase in debt.

So no apologia from folks like you can be allowed to stand without pointing out that S&P helped to create the problems they now decry.

Posted by RichardTaylor | Report as abusive

If you’re trying to craft a defense of S&P’s downgrade using the argument that it was a political, rather than an economic evaluation, you’ve missed the mark by a bigger margin than S&P did.

There are a limited number of future scenarios affecting any future debt limit debates: Dem President/Repub Congress, Dem President/Dem Congress, Repub President/Repub Congress, Repub President/Dem Congress. In only the first of those scenarios does the debate even occurr — a Democratic President and a Republican Congress. Since, as you know very well, the whole sideshow was never actually about deficits but was about demaging the Democratic President’s chances for re-election, under a Republican President it never would have happened; even with a Democratic Congress. A Republican Congress would have no reason to start the argument, and Democratic Congresses just don’t play scorched-earth economic games.

And as we all saw, the only likely outcome under a Democratic President facing Republican intransigence is the Democrat caving — because Dems don’t play brinkmanship with the economy. Somebody in the room has to be the grownup.

This was not actually an example of dysfunctional Washington — that would imply the ‘crisis’ was beyond control. This was a Republican political class getting everything it wanted from the episode: “98%” of their economic demands and a seriously weakened Democratic President.

So – as a political matter — the risk of future default is exactly equal to what it was this time. Zero.

Posted by flory | Report as abusive

The entire business model of rating agencies is flawed. It is not that people do not know the state of the economy. People like PIMCO, MS, BoA, Goldman they all know the state of the economy. Everyone including public make their judgement. Rating agencies judgement cause more harm than a solution.

Posted by _Raghunath | Report as abusive

Felix, I have a few questions:

1) By S&P’s logic, what sovereign deserves a triple A rating?

2) The 14th Amendment requires that all debts (not obligations) must be paid. Additionally, I am not aware of any congressperson who advocated not debt default, and in fact the house of representatives passed a bill that prioritized payments in the event the debt ceiling was not raised, guaranteeing interest be paid on the debt. It seems to me therefore that passing some additional laws and making a deal to get rid of the debt ceiling should be enough to regain our AAA rating. Do you agree?

3) Can you please elaborate on the differences between S&P and Moody’s rating criteria?

Posted by andrew12345 | Report as abusive

Felix,

your political argument would hold if they had not down graded Japan in 2002. Has Japan ever lacked the political will to raise their borrowing limit or is this just plain obsession over the national debt of a country in a balance sheet recession?

Posted by ssn | Report as abusive

Felix, I’d be interested to hear your response to a retired Moody’s sovereign rating director who says the downgrade was unwarranted.

http://economistsview.typepad.com/econom istsview/2011/08/retired-moodys-sovereig n-rating-director-the-sp-downgrade-is-un warranted.html#comments

Posted by AASH | Report as abusive

@flory August 7 at 7:28p gets it right on the political argument, a fact which can be summarized here by saying:

Would anyone, including Felix, seriously argue that a Republican controlled House and a Republican OR Democratically controlled Senate – even without a filibuster proof majority – would vote NOT to raise the debt ceiling if a Republican was sitting in the White House?

If the answer to that question is “No” – go ahead, Felix, destroy ALL your political analysis credibility and answer “Yes” – then the argument really does shift back to the materiality of the economic argument that S&P saw fit to EXCISE from its downgrade after its $2 trillion error was pointed out by Treasury.

Or is Bellows at Treasury being (deliberately?) misleading when he writes:

http://www.treasury.gov/connect/blog/Pag es/Just-the-Facts-SPs-2-Trillion-Mistake .aspx

“This [$2 trillion] mistake undermined the economic justification for S&P’s credit rating decision. Yet after acknowledging their mistake, S&P simply removed a prominent discussion of the economic justification from their document.”

The claim that Bellows is making is clear enough, i.e., that the economic argument – which went up in smoke when the $2 trillion error was pointed out – was “prominent” in S&P’s first pass.

Assuming that Felix is correct that S&P has no motive to rig the game (e.g., to try to provide some counterweight to its obvious lack of objectivity and competence after the debacle of AAA MBS), presumably S&P should have no objection to releasing the unexpurgated version of its initial downgrade report and let Felix – and the rest of us – judge for ourselves how material the economic argument was initially to S&P’s downgrade.

I couldn’t find the unexpurgated version at S&P’s website. Has anyone else been able to locate it? Maybe Felix can get S&P to send him a copy and provide all of us with a red-lined version, along with his own close reading as to why the excised portions of S&P’s original argument do not materially effect what it finally presented?

That would be much better than simply relying on an airy statement about why the economic argument did not matter because any reasonable person, such as Felix, could see that the decision was logically dominated by a cogent political argument – the cogency of which @flory has seriously called into question.

BTW, Felix’s airy statement was made ever airier by quoting Tyler Cowen to the effect that, though not specifically mentioned by Cowen, someone like Paul Krugman, who does think that getting your math right matters, is “trying to muddy the broader issues.” Isn’t Felix just a bit uncomfortable cherry picking a quote from Krugman and juxtaposing it next to the quote from Cowen in a manner which suggests that Krugman’s only — or even main — objection to S&P’s downgrade, was its uncontestedly demonstrated prior ratings incompetence?

It strikes me that anyone who concurs – alas, rhetorically rather explicitly — with someone else who suggests that the “simple[minded] rule of thumb” which Cowen proposes might apply to the historical, methodological, and substantive criticisms that Krugman has marshaled against the probity of S&P’s downgrade — suggests in a word that Krugman has been “muddy[ing] the broader issues” on the debt-ceiling debate and the downgrade — is ripe for a Harvey Johnson moment.

Posted by billyblog | Report as abusive

Looks like the GOP supporters are out flaming again. Shoot the messenger, why don’t you? $2 trillion of extra military spending caused by Bush policies is the way to support America, not tax rises! It’s denying attitudes like this that will continue to damage the West. Plonkers.

Once upon a time honour and responsibility, together with some talent, were the prerequisites of being a good politician; these days it’s all about who can get angriest, shout loudest, and be least responsible it seems.

Posted by FifthDecade | Report as abusive

Finally a well-written piece with a well articulated and clearly presented argument. You did get carried away at the end though with the “100% dysfunctional Congress” – in America, they always are and that’s why you have a system of checks and balances (inlcuding bicameral assembly, strong executive and independent judiciary). The problem really is that such systems are very effective in perpetuating the status quo but miserably fail when you need to conduct reforms.

Posted by Tseko | Report as abusive

your defense would be persuasive if there were some kind of statistical evidence that AA/AAA ratings were related to default probabilities, and they are not (see Nate Silver’s column for good analysis, linked at the bottom). So France deserves AAA even though it’s exposed to Greek and Irish debt?

http://fivethirtyeight.blogs.nytimes.com  /2011/08/08/why-s-p-s-ratings-are-subst andard-and-porous/

Posted by dwb3 | Report as abusive

France isn’t exposed the Tea Party run GOP.

Posted by FifthDecade | Report as abusive

It’s clear Felix Salmon is getting desperate on his earlier lame defense of the indefensible S&P downgrade.

On the “econometric” side, Salmon now treats us to an explanation of how S&P does what it does in sovereign debt ratings which amounts to one of the best – though surely unintended – arguments for why S&P’s methodology is so one dimensional as to be, practically speaking, useless when it comes to rating sovereign debt. Why even bother when the methodology is so terribly flawed from an investor standpoint, especially since there can be undeserved consequences for a reckless performance, such as the one we have just seen.

On the political side, Salmon is either being disingenuous, or simply not a very perceptive reader of what Nate Silver wrote. A side-by-side comparison of what Silver wrote and what Salmon represents him as having written unfortunately strongly suggests the former.

Salmon writes:

“Silver also has a big problem with the fact that S&P ratings are more correlated with the Corruption Perceptions Index than they are with things like GDP growth or inflation, or debt. That fact, he says, “suggests that S&P is making a lot of judgment calls about countries.” Which, well, yes. Sovereign defaults are always political, rather than economic: if you looked only at macroeconomic ratios, then Ecuador should be investment grade, as would just about any other country which has recently defaulted and wiped out most of its debt. A sovereign credit rating is therefore primarily a function of a country’s willingness to pay, rather than its ability to pay.”

Silver wrote:

http://fivethirtyeight.blogs.nytimes.com  /2011/08/08/why-s-p-s-ratings-are-subst andard-and-porous/#more-14347

“What factors is S.&P. looking at when it rates sovereign debt? A country’s debt-to-G.D.P. ratio? Its inflation rate? The size of its annual deficits?

“S.&P. does look at each of these factors. But it also places very heavy emphasis on subjective views about a country’s political environment. In fact, these political factors are at least as important as economic variables in determining their ratings.

“For instance, the S.&P. ratings have an extremely strong relationship with a measure of political risk known as the Corruption Perceptions Index, which is published annually by Transparency International. These ratings have been the subject of much criticism because they are highly subjective, relying on a composite of surveys conducted among “experts” at international organizations who may have spent little time in most of the countries and who may instead base their judgments on cultural stereotypes.

“I don’t know whether or not S.&P. looks at these ratings. But the fact that the two sets of ratings are so closely related is troublesome. It suggests that S.&P. is making a lot of judgment calls about countries they have no particular knowledge about. Keep in mind that even when it comes to the United States, S.&P. made a $2 trillion error that reflects their lack of understanding of the way that bills are scored by the Congressional Budget Office. Are we to expect that they add value based on their perceptions of the political climate in Kazakhstan, or Cyprus, or Uganda?”

Is there anyone reading this blog who thinks that Salmon has not distorted what Silver said?

Notice in particular the deliberate – there is no other word for it — butchering of Silver’s sentence:

“It suggests that S.&P. is making a lot of judgment calls about countries they have no particular knowledge about.”

The whole point of that sentence was at the backend, where Nate says: “about countries they have no particular knowledge about.” Salmon leaves off the “they have no particular knowledge about” part and immediately segues into “Which, well, yes. Sovereign defaults are always political, rather than economic,” as if poor Nate had just said something so anodyne and obvious that any intelligent person would wonder why he said it in the first place.

Give it up Felix.

S&P shot itself in the foot on the econometric side, as Krugman et al pointed out,* and Salmon agreed, though he tried to trivialize this egregious error … and then take refuge in the validity – in his mind – of S&P’s political analysis.

And when Silver provided a powerful argument for why we should discount S&P’s ability in the area of political analysis as well, Salmon’s response was to grossly under- and outright misrepresent what Silver said on this point.

Very Republican of you, Felix.

Why not just admit “Hey, I sometimes make mistakes,” and move on?

*BTW, there was a similar pattern of misrepresentation in Salmon’s treatment of Krugman in one of his previous posts on this subject.

http://blogs.reuters.com/felix-salmon/20 11/08/06/the-credibility-and-integrity-o f-sp%E2%80%99s-ratings-action/

Salmon juxtaposed a quote from Krugman in which Krugman was excoriating S&P’s past econometric sloppiness – and current $2 trillion mistake — as disqualifying it from doing its downgrade with a quote from Tyler Cowen supposedly preemptively answering methodological criticisms such as Krugnam’s as being those of a “commentator … trying to muddy the broader issues.” Salmon – and, of course, Cowen – are free to disagree with Paul Krugman. But who except one of the autodidact trolls that frequent Krugman’s blog would ever accuse Krugman of “muddy”[ing], let alone not bringing into the discussion quite explicitly, the “broader issues”? In particular, I cannot imagine Tyler Cowen saying that Krugman was one of the commentators to whom his quote applied. Though that is exactly what Salmon disingenuously suggested by his juxtaposition.

Posted by billyblog | Report as abusive

It never ceases to amaze me, how many people are so easily duped by BAD JOURNALISM, and then are controlled by the deceptions to keep spouting and repeating those inaccuracies. UNTIL very RECENTLY 97% of our government public Servants have been pulling the wool over our eyes, robbing the till, taking bribes, committing fraud, and shredding the Constitution slowly and quietly. All of a sudden the people began to wake up, and from ALL parties they began to form a grass roots movement to take back our government. It is called the Tea Party. Naturally, There is a great deal of backlash from all of the Socialist govt and media control freaks. Thus it SEEMs to observers like there is a majority of “thinking people” who agree that the Tea Party is made up of a bunch of psychopathic, racist, sexist, hate-mongering, homophobic, religious, morons; Therefore it MUST be true. So we get the ridiculous comments above blaming them. The Truth is our Public Servants have been overspending, and maxing out our credit, which have been driving us inevitably toward the cliff, and Now that there was a veiled threat – suggested conveniently by the Dems with the most to lose if the TP are seen as the heroes they are – The Tea Party folks are only insisting that we get our finances in order. If we are going to avoid default, or recover from default, we are going to have to do exactly everything that the TP has been demanding, and the sooner we do, the better. Every day that we delay to do these things will delay the recovery time exponentially. The Tea Party represents me, and millions of others who want the American Dream back, and it will only be acquired from the bullies, with a gun to our head, who have taken it by the tenacity of the bull dog who bites and refuses to let go until the bullies let go of the gun.

Posted by Eph4_15 | Report as abusive