S&P Called On The Carpet?

As we predicted, Congress has indicated that an investigation of Standard & Poor’s could be in the works, given recent comments by the Senate Banking Commitee chairman.

The guest in the video holds all of the typical Wall Streeter views on this issue:

• S&P courageously did the “dirty work” of daring to downgrade the U.S. government.
• U.S. deficits and debt are unsustainable, and markets need the “confidence” that fiscal consolidation would confer.
• The downgrade should motivate the USG to come to a compromise consisting of spending cuts and some degree of tax hikes if necessary.

As we’ve argued before, those sound exactly right, except that they couldn’t be more wrong once you grasp how most monetary economies operate today.

There is no fiscal or financing crisis facing the United States government, which spends before it ever has to “borrow”, and whose borrowing simply reflects (1) the desire of U.S. dollar holders to own an interest-bearing equivalent and (2) the results of the Federal Reserve’s interest rate targeting operations.  

Instead, the “real problems” facing the country are unemployment at more than twice the level and three times the duration that prevailed prior to 2008.

But because so many people fear that S&P is right, and that there really is a fiscal ‘crisis’ facing the U.S. (due to the failure to understand that every dollar of federal deficits is a dollar of savings for the rest of the economy, just as every ounce of gold mine deficits represented new savings under a gold standard), they advocate policy measures that are guaranteed to keep us on a path like Japan’s. And in Japan’s case, every negative outlook and eventual downgrade of Japanese government debt by the ratings agencies has been ignored.

For those who claim that S&P was right because the U.S. is sure to ‘inflate its debt away’, Japan is an instructive example. Despite the downgrades, government bond prices kept rising, yields kept falling, and bond holders were additionally rewarded by deflation, where future interest and principal payments buy more than they would today. If anything, Japan’s government rating in such an environment should have been well above AAA. It tells us, at the very least, that the rating agencies’ models have it ass backwards when it comes to the debt of truly sovereign governments, and that Carmen Reinhart and Bill Gross’ assertions of “financial repression” are beyond the pale.

As for the idea that S&P did something difficult and courageous here, a $2 trillion rounding error, a failure to distinguish between ability and willingness to pay, suspicions that this was motivated by a desire to please governments and institutions in Europe where it openly hopes to expand its rating business,  and more sober analyses from Fitch and Moody’s all call that view into question.

I’m not normally one for Congressional inquiries into business activities—for example, calling the oil companies before Congress several years ago was a bizarre spectacle—but S&P should be called to account for this:

• They enjoy a privileged, oligopolistic position in the financial markets (read economic rents).
• What they wrote in the report and have said since simply don’t add up.
• They have consistently played a central role in some notable financial market failures.

Coming as it does on top of their egregious errors in the subprime mortgage crisis and the Enron era, as well as multiple prior failures (see below), you have to wonder just how consistently incompetent a ratings agency has to show itself to be before its privileges are finally yanked:

The rating agencies had, of course, been shown to be spectacularly wrong before Enron. Washington Public Power Supply System, was aptly referred to as ‘whoops.’ Other debacles in the rating agency hall of shame have included Executive Life, the “Asian Flu,” Orange County, [California,] and National Century Financial Enterprises (NCFE). (Claire A. Hill, “Why Did Anyone Listen to the Ratings Agencies After Enron?” Journal of Business and Technology Law, accessed online 8/10/2011)

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