If Geithner didn’t bully S&P, he should have
As part of its defense against a Department of Justice lawsuit alleging $5 billion in fraud, ratings agency Standard & Poor’s has argued that the United States has singled it out for persecution as payback for S&P’s 2011 downgrade of U.S. Treasury debt from “AAA” to “AA-plus.” Harold McGraw, chairman of McGraw Hill Financial, the owner of S&P, says that an angry Treasury Secretary Timothy Geithner called to threaten him after the downgrade, warning ominously that he had earned the government’s ire and scrutiny. A spokesman for Geithner, who now works for a private equity firm, denies the claim.
Well, if it’s not true, it should be. As Treasury Secretary, Geithner represented the financial interests of the American citizens who might have suffered greatly had fixed income and equity markets not ultimately shrugged off the downgrade. The S&P downgrade could have caused U.S. borrowing costs to spike, hurting the government’s ability to refinance its debts at a crucial moment in the economic recovery. It might have made already scarce credit less available to businesses and consumers operating throughout the economy.
Besides, S&P made a mistake in its calculations, overestimating the total debt outstanding by $2 trillion. Even after Treasury pointed this out and S&P agreed, the agency stuck by the downgrade. The report that S&P issued was really more of a “letter to the editor” than financial analysis. S&P downgraded the U.S. largely based on the dysfunctional reality of divided government that led to a near breach of the debt ceiling. S&P is entitled to its opinion, but putting the U.S. on the same credit footing as Lichtenstein over a public political dispute that everybody already knew about seems silly in hindsight and didn’t make much sense even then, as Warren Buffett pointed out.
The move did win some attention for S&P and allowed the agency to claim its independent mindedness and willingness to make tough calls. But the agency had showed little of that resolve when it came to taking fees for rating mortgage backed securities for its private clients. At issue now is whether or not S&P handed out inflated ratings for asset-backed securities so as not to kill the lucrative new issue market. This is the same S&P that years earlier exhibited extreme credulity about Enron’s solvency. Enron was another big debt issuer and thus a fee-generating player in the debt markets.
But, howl the Wall Street Journal editorial writers, the government cannot be seen as bullying private companies like S&P. This ignores the fact that the government is the reason S&P has a business in the first place. The SEC recognizes Nationally Recognized Statistical Rating Organizations, and that imprimatur is what allows public companies and investors to make use of S&P’s ratings when issuing new securities or reporting on the quality of their own balance sheets. Anyone can analyze a bond or make a judgment about the credit worthiness of an entity issuing securities. But S&P is, because of the government’s blessing, among a handful of organizations with ratings that are part of the financial lingua franca. For McGraw Hill this means $227 million in operating profit from its ratings unit in the third quarter of 2013. S&P is less being abused by the government than it is a ward of the state.
Now, let’s look at the allegation made by McGraw. He says that Geithner called him to complain about the $2 trillion mistake. There’s nothing inappropriate about that. Geithner was angry. S&P sometimes angers people with its ratings. Those people have as much a right to an opinion about S&P as S&P has a right to an opinion about their credit worthiness. Geithner threatened that the government would be watching the agency carefully. As well it should. The S&P operates its entire business with the government’s endorsement.
None of this makes the DOJ lawsuit some sort of retribution. When Geithner called S&P to complain, he apparently got nowhere. The downgrade happened. It has not been revised despite two and a half years of an improving economy. S&P has stuck to its standards.
Had S&P been so careful and resolute while rating mortgage bonds, perhaps a great deal of financial pain might have been avoided. Perhaps it would have earned its status as a recognized rating organization. It might have lessened the severity of the financial crisis and even prevented the events that sent the government hurtling toward default in 2011.
McGraw might want to play the victim of conspiracy now, but his best defense in the future would be for S&P’s analysts to do a better job and to stand up to the private debt issuers who pay their fees just like McGraw allegedly stood up to Geithner.
PHOTO: U.S. Treasury Secretary Timothy Geithner avoids a reporter’s question as he departs after testimony regarding the annual report of the Financial Stability Oversight Council before the House Financial Services Committee on Capitol Hill in Washington, July 25, 2012. REUTERS/Jonathan Ernst