The poor standards of Standard and Poors

There was a bit of brouhaha on Monday when the credit ratings agency Standard & Poors talked of a one-in-three chance that US Treasury securities could be downgraded by the company to "negative" in three years. The warnings were based on projections of federal deficits and were welcomed by many in the punditry, in politics and in the financial sector who want to make deficits the centerpiece of any immediate economic agenda.

But one wonders how much credence should be given to Standard and Poors?  How much of what they publish is tailored to what Wall Street wants to hear and carefully aligned in their immediate interests?

The Congressional Financial Crisis Inquiry Commission has judged S&P and the other ratings agencies as key players in the big stakes deceptions and fundamentally fraudulent mortgage bundling that was at the center of the 2008 financial meltdown. For example, last fall, via the New York Times reporting of the Crisis Inquiry hearings, we learned this:

D. Keith Johnson, a former president of Clayton Holdings, a company that analyzed mortgage pools for the Wall Street firms that sold them, told the commission on Thursday that almost half the mortgages Clayton sampled from the beginning of 2006 through June 2007 failed to meet crucial quality benchmarks that banks had promised to investors.
Yet, Clayton found, Wall Street was placing many of the troubled loans into bundles known as mortgage securities.

Mr. Johnson said he took this data to officials at Standard & Poor’s, Fitch Ratings and to the executive team at Moody’s Investors Service.

“We went to the ratings agencies and said, ‘Wouldn’t this information be great for you to have as you assign tranche levels of risk?’ ” Mr. Johnson testified last week. But none of the agencies took him up on his offer, he said, indicating that it was against their business interests to be too critical of Wall Street.

So anything coming from Standard and Poors needs to be taken with some very large grains of salt. In this vein, emeritus Amherst economics professor Richard Wolff, in an article for the UK Guardian, called the S&P warning,"another scary instalment in the conservative campaign to justify cutting government social spending. S&P may be rampant in its interests, but it hardly seems conflicted about them." 

Simon Johnson, former chief economist for the International Monetary Fund, also had some appropriately skeptical comments on S&P's pronouncements at the NYT's Economix blog:

It is commendable that S.&P. now wants to talk about the United States fiscal deficit –- one wonders where it was, for example last year, during the debate about extending the Bush-era tax cuts.

In January, both S&P. and Moody’s Investors Service warned that the United States might tarnish its credit rating if its national debt kept growing. Though the latest S.&P. report did not explicitly refer to the coming Congressional vote over raising the debt ceiling, it certainly added an element to the debate.

But S.&P. did not lay out even the most basic numbers or point readers toward the nonpartisan and definitive Congressional Budget Office analysis of medium- and longer-term budget issues. This matters, because the C.B.O. numbers definitely do not show debt exploding upward immediately from today...

Two serious budget issues are made clear by the C.B.O. analysis. First, the big increase in debt in recent years has been primarily due to the financial crisis. To see this, compare the January 2011 C.B.O. forecast cited above with its view from January 2008 (see page XII, Summary Table 1), before the seriousness of the banking disaster — and the ensuing recession — became clear.

At that point, the C.B.O. expected federal government debt relative to gross domestic product to reach only 22.6 percent in 2018 (compared with the 75.3 percent for 2018 from the 2011 projections.)

In other words, the financial crisis will end up causing government debt to increase by more than 50 percentage points of G.D.P. over a decade. This is the major fiscal crisis of today and the likely one tomorrow...

A future financial crisis, given the nature of our economy, could well cause a debt increase of more than 34 percent of G.D.P. — just look at what happened this time in the United States or the way in which Ireland was ruined by big banks and reaction by the politicians there...

There is, of course, a longer-run budget issue — beyond 2020 –- that is mostly about health care costs. S&P. follows the current consensus by flagging the Medicare component of this...

But the real threat to the economy is health-care costs seen broadly, not just the Medicare component...

Will its broad-brush and somewhat indiscriminate warning push politicians to sensible debate and eventual action –- with regard to both the financial system dangers (the medium-term issue) or health care costs (the longer-term issue)?

Perhaps, but this sort of “warning” may also whip up debt hysteria of a kind that can quite easily lead to policies that quickly undermine growth.

Standard and Poors is most reliable as a functionary of the same interests that got us into the current mess - via decades of tax-cuts-over-everything political opportunism and deeply ingrained corporate overreach to the point of "legalized fraud" driving the financial sector.

There is good reason to worry about long-term deficits and how best to reduce them - with medical costs across the board being the main driver, absent another major financial meltdown. But arm-waving by the banksters' friends at Standard and Poors is not one of them.

8/6/11 UPDATE, HERE.