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It’s time for the United States of America to downgrade Standard & Poor’s credibility

Almost immediately after Standard & Poor’s revealed on Friday that it was downgrading the United States’ credit rating to AA+ from AAA, the decision became fodder for critics of the Obama administration.

Among the loudest critics are the bevy of 2012 Republican presidential candidates, who have tried to blame America’s economic woes on the Democratic Party despite the fact that the policies of the last Republican administration (under George W. Bush) contributed to the collapse of the economy in the first place.

The way they’ve characterized the downgrade makes us wonder if they even bothered to read Standard & Poor’s announcement, which cited political gridlock in D.C. as a factor that contributed to their decision. It takes two to tango, as the saying goes. Since the midterms, we’ve had divided government.

Had Republicans not taken control of the House of Representatives, the debt ceiling likely would have been raised in the same manner that it has been in the past. But the right wing thought that they could profit politically by making the possibility of default seem real. And they deviously carried out their threat, precipitating a phony crisis that was only ended by an eleventh hour deal.

Now, ignoring their own role in the deficit and debt ceiling showdown, they are on the attack, portraying the Obama administration as inept and portraying the Standard & Poor’s decision to downgrade as proof.

But Standard & Poor’s is hardly an institution that is qualified to lecture others on fiscal responsibility. It is one of three ratings agencies (the others are Moody’s and Fitch) which completely and utterly failed to blow the whistle on the bad bets that Wall Street was making. As Bethany McLean and Joe Nocera explain in All the Devils Are Here (The Hidden History of the Financial Crisis):

The ratings agencies had always been stingy about bestowing triple-A status on corporate debt. In 2007, for instance, only six companies had a triple-A rating. Yet when it came to tranches of mortgage-backed securities, the ratings agencies handed out triple-As like candy. Literally tens of thousands of mortgage-backed tranches were rated triple-A.

In the early years, the securities performed well. That was true even of the relatively small batch of asset-backed securities that used subprime mortgages. They had plenty of credit enhancements, and besides, housing prices were going up, the way they were “supposed” to, which kept defaults to a minimum. But the rating agencies continued to slap their triple-As on subprime securities even as the underwriting deteriorated and as the housing boom turned into an outright bubble, waiting to burst. When it did burst, the rating agencies, and the investors who had depended on them, were caught flat-footed.

Nocera and McLean go on say that Wall Street’s house of cards simply could not have been built without Standard & Poor’s (and their two counterparts).

The ratings agencies were at the very heart of the madness. The entire edifice would have collapsed without their participation. “Get the rating out the door – that was it, says a former S&P executive. Once a tranche of a mortgage-backed security was stamped triple-A, nobody ever went back and reanalyzed it as it was rebundled into a CDO [CDO stands for collateralized debt obligation, or securities that comprise the debt of different companies or tranches of asset backed securities].

Emphasis is mine.

Given that S&P failed to sound the alarm about Wall Street’s bad bets, why should we trust its analysis now? We shouldn’t. S&P doesn’t deserve to be taken seriously. What’s more, we actually know for a fact that S&P is still making errors.

This isn’t just conjecture or suspicion. Here’s John Bates, the Acting Assistant Secretary for Economic Policy at the Department of the Treasury:

In a document provided to Treasury on Friday afternoon, Standard and Poor’s (S&P) presented a judgment about the credit rating of the U.S. that was based on a $2 trillion mistake.

After Treasury pointed out this error – a basic math error of significant consequence – S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.

Bates added:

S&P has said their decision to downgrade the U.S. was based in part on the fact that the Budget Control Act, which will reduce projected deficits by more than $2 trillion over the next 10 years, fell short of their $4 trillion expectation for deficit reduction. Clearly, in that context, S&P considers a $2 trillion change to projected deficits to be very significant. Yet, although S&P’s math error understated the deficit reduction in the Budget Control Act by $2 trillion, they found this same sum insignificant in this instance.

He concluded his statement several paragraphs later by saying, “The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raise fundamental questions about the credibility and integrity of S&P’s ratings action.”

We at NPI would argue the mistake is just more evidence that the credibility and integrity of S&P itself is shot. As Paul Krugman put it:

In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.

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

Warren Buffett, who is one of the world’s wealthiest men and one of the country’s most respected investors, also criticized S&P, telling Bloomberg Television that the United States deserved a “quadruple A” rating. He made similar comments to Rupert Murdoch’s Fox Business network. “In Omaha, the U.S. is still triple A. In fact, if there were a quadruple-A rating, I’d give the U.S. that,” Buffett said.

The time has come for the United States of America to downgrade the credibility of Standard & Poor’s. Why is it that we have rules that give S&P and its counterparts “almost Biblical authority” (as New York City’s former finance administrator Roy Goodman put it) when they are not neutral observers of the markets, but rather for-profit companies themselves. The Dodd-Frank Wall Street reform bill based last year tweaked the rules to some extent, but it didn’t bring about the real regulatory changes that we need. The rating agencies still enjoy an aura they don’t deserve when their reputations should be in tatters.

On behalf of the people of this country, Congress and President Obama ought to let S&P know what we collectively think of their credibility by stripping the rating agencies of their legal role in evaluating credit.