By JEANNETTE NEUMANN and AARON LUCCHETTI
Standard & Poor's unprecedented decision to strip the U.S. of its top credit rating was the downgrade heard around the world.Friday night's move dramatically showed that the unit of McGraw-Hill Cos. no longer believes long-term U.S. government debt is among the very safest investments in the world. S&P also veered away from its reputation during the financial crisis, when critics said the firm lost its independence.
S&P now is on the defensive yet again. John Bellows, acting assistant secretary for economic policy, said Saturday in a blog on the Treasury's website that the downgrade 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," Mr. Bellows wrote.
S&P President Deven Sharma said in an interview that there was a discrepancy over which discretionary-spending projections the rating firm should use for its analysis. S&P was using an estimate provided by the Congressional Budget Office, Congress's chief budget scorekeeper, while Treasury officials wanted S&P to use a different estimate.
It eventually did, Mr. Sharma said.
"There was a change in the assumption, but the dynamics of the near-term and the medium-term are still the same: The debt trajectory will continue to increase," Mr. Sharma said Saturday. The firm's role, he said "is to call the risk when we see it."
The fierce resistance from the Obama administration is "the same you would get from any other country or company," Mr. Sharma said. "We are supposed to be objective, and others are always trying to convince us why the risk is less than we think it is."
S&P also held a rare Saturday afternoon conference call for journalists, defending the rationale for its rating.
S&P's downgrade put the ratings firm at odds with Moody's Investors Service, a unit of Moody's Corp., and Fimalac SA's Fitch Ratings. Those two firms haven't budged from their top-notch ratings on U.S. government debt. S&P downgraded long-term U.S. debt to AA+ and put the new grade on "negative outlook," meaning the U.S. could be downgraded again in the eighteen months to two years.
Officials at S&P were the first at any of the three big credit-ratings firms to put Treasury debt on "negative" outlook. The April move meant there was a one-third chance of a future downgrade. On July 14, S&P warned that there was a 50% chance of a rating cut on U.S. debt. Friday night's downgrade came about four hours after stock markets closed in the U.S. Rumors swirled all afternoon that a downgrade could be imminent.
Widely criticized during and after the financial crisis for overly optimistic ratings on mortgage securities that later suffered steep losses, S&P has worked hard to convince financial markets, lawmakers and regulators that it still can be relied on for independent analysis.
But some longtime rivals and critics of S&P questioned Saturday the firm's decision to strip the U.S. of its triple-A rating.
It was "overly aggressive" and "precipitous," said Jules Kroll, whose Kroll Bond Rating Agency has stayed out of the sovereign-debt ratings business. "It's just one more manifestation of lurch-like behavior to try to make up for past sins."
David Riley, a Fitch analyst, said a downgrade by Fitch would be "premature" because it is waiting to see the outcome of deliberations by the Joint Select Committee, created by the debt-ceiling bill to hammer out the details to reduce the deficit. Fitch expects to finish its U.S. rating review by the end of August.
Moody's analyst Steven Hess said Saturday that while the tone among US politicians "is important, the bottom line is what they actually do." He added that the U.S. debt limit compromise "is a positive move, and we wouldn't see the passage of the act as a negative for the rating." Moody's has U.S. debt on a negative outlook, which gives the rating firm time--perhaps as long as two years--to assess new developments in the economy and the U.S. debt picture.
Sean Egan, the president of Egan-Jones Ratings Co., a small firm that downgraded U.S. debt from triple-A to AA+ in July, said S&P is "doing everything they can to restore credibility."
Mr. Egan's downgrade of U.S. debt had more to do with the country's debt burden in relation to the size of the economy and less to do with the political dysfunction cited in Standard & Poor's downgrade report, he said.
Daniel Alpert, managing partner of Westwood Capital, said Saturday that he disagrees with S&P's political conclusions, calling the downgrade "ill conceived." But he added that the firm "did this out of a feeling of responsibility."
A "general resentment" of rating firms in Europe may have also played a role, Mr. Alpert said, since some people there regard the firms as "self-righteous Americans who have no business judging" European sovereign debts with as much criticism as they have.
S&P's downgrade of long-term U.S. debt shows it isn't biased in favor of the home country of the ratings firm or its parent, McGraw-Hill, Mr. Alpert said Saturday.
"There's a level of activism at S&P that I haven't seen before," said James Gellert, chief executive of Rapid Ratings, a bond research firm.
The downgrade, Mr. Sharma said, "should reinforce to investors and the marketplace broadly that we make the calls on the credit risk as we see it, to the benefit of investors."
It isn't easy for one credit-ratings firm to distance itself from the pack. Because of their dominance of the industry, the Big Three firms--S&P, Moody's and Fitch--often are lumped together by lawmakers, regulators and the general public.
All three firms were denounced during and after the financial crisis by critics who claimed they assigned their highest ratings to questionable deals, particularly on securities backed by residential mortgages, in order to win and keep business from the issuers of those bonds.
S&P, Moody's and Fitch downgraded thousands of mortgage bonds, starting in 2007, when they realized that the housing downturn made many triple-A rated bonds shaky. Those bonds plummeted in value, hurting investors who bought them and leading to a loss of confidence in rating firms that blessed the securities with high ratings.
As part of a campaign to restore its credibility, S&P published in November 2009 a report called "Big Changes in Standard & Poor's Rating Criteria," followed in February by "More Big Changes in Standard & Poor's Rating Criteria." S&P made it tougher to get a triple-A rating for residential mortgage-backed securities deals and spelled out in greater detail how it rates U.S. states. S&P also has issued requests for comment on all of its major, recent criteria changes.
The requests for input show S&P "is receptive to being shown a better mousetrap," Mark Adelson, the firm's chief credit officer, said in a recent interview. "It helps make a better product."
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