The credit ratings firm Standard & Poor’s doesn’t exactly have a stellar record in predicting the future. It missed the flaws in Orange County’s investment portfolio that led to the county’s 1994 bankruptcy. It missed the cancer eating away at Enron. It missed the mortgage meltdown.
But good news: It’s now getting into political prognostication.
Last week S&P issued a blockbuster report on the credit prospects of the U.S. government. While maintaining the government at its highest rating, AAA, the firm revised its “outlook” on the government’s future creditworthiness to “negative.” That signifies there’s a 1 in 3 chance that S&P will downgrade its ratings on government debt sometime in the next two years. S&P said it’s not convinced that Congress and the White House will get their act together to bring the federal deficit under control by 2013.
The U.S. downgraded, like a homeowner bailing on his mortgage? The prospect sent the stock and bond markets skidding — for a spell. White House economic advisor Austan Goolsbee stood in front of CNBC’s cameras to say S&P didn’t know what it was talking about. GOP deficit hawks in Congress, on the other hand, proclaimed that S&P had “sent a wake-up call to those in Washington asking Congress to blindly increase the debt limit,” to quote House Majority Leader Eric Cantor of Virginia.
What possessed S&P to inject itself into the biggest political controversy of the moment isn’t clear. Perhaps the firm wants to look relevant again, after abandoning its professional responsibilities in the run-up to the financial crisis of 2008.
Possibly it’s looking to hang out its shingle as political consultantship, since its old business of rating fixed-income investments isn’t what it used to be. Possibly its analysts genuinely wish to communicate a warning about the nation’s fiscal path. The important question is whether S&P told us anything we didn’t know, or did it just muddy the debate over the deficit?
The last time the government faced the threat of a downgrade was in 1996, when Moody’s Investors Service placed the government on credit watch because Republicans in Congress had balked, temporarily, at raising the federal debt limit. That’s an eventuality that does indeed raise the prospect of default, because reaching that ceiling means the government cannot pay its debts.
Interestingly, the government faces the same situation now, with some GOP members of Congress threatening to block an increase in the debt limit (as Cantor hinted). Yet, oddly, S&P said it wasn’t at all concerned about that. “We do not expect the government to default” because of a congressional rejection of the increased debt limit, it said.
That only makes S&P’s reasoning murkier. Short of a blockade on the debt limit, there is virtually no way the U.S. government can default on its debt — as a sovereign nation, if worst comes to worst it can simply print sufficient greenbacks to pay its bills. In other words, the firm was basing its judgment strictly on today’s political situation.
Before we get into why that’s a peculiarly unwise step for a financial analysis firm to take, let’s detour to the issue of whether Standard & Poor’s has the credibility to speak out about anything just now.
Consider S&P’s role in the financial meltdown, the recovery from which has, of course, necessitated much of our current deficit spending — including deficit-financed bank bailouts, deficit-financed unemployment relief and deficit-financed economic stimulus.
Standard & Poor’s is one of three credit rating companies (the others were Moody’s and Fitch) hired by the panderers of risky mortgage securities and derivatives to endow these soiled wares with glossy triple-A ratings, which the sellers coveted to quell the doubts of investors.
But S&P and the other firms were hopelessly conflicted: Their fees were based on the dollar values of the securities issues they were hired to rate. That gave them an incentive to treat any flaws they might have perceived in the issues’ creditworthiness with, shall we say, tolerance. Get a reputation for saying no to the guy paying your fees, and bing! Kiss your market share goodbye.
The rating firms’ derelictions didn’t only cost mortgage investors money. By allowing banks and their regulators to be complacent about the quality of the assets on the banks’ books, the credit agencies helped to impair the health of the entire financial system.
The bipartisan Financial Crisis Inquiry Commission concluded in its report issued in December that “the failures of credit rating agencies were essential cogs in the wheel of financial destruction.” This judgment was shared by the Democratic majority and Republican minority on the panel. (As for Orange County and Enron, S&P settled a lawsuit filed by the county for chump change in 1999, and maintained that it overestimated Enron’s credit health because it was misled by the company’s brass.)
So S&P’s record hardly inspires confidence. That alone doesn’t mean the firm’s judgment about U.S. government credit should be dismissed offhandedly. But what did the firm actually say?
Essentially, that the U.S. hasn’t moved as quickly as Britain, France and Germany to get its fiscal house in order after the Great Recession. The firm projected that the U.S. deficit would stick above 6% of gross domestic product in 2013 and net government debt would be 84% of GDP. Its analysts were unnerved that “U.S. policymakers have been unable to agree” on a deficit-cutting strategy, while those other countries are well on their way to austerity.
That’s not an unreasonable finding, as far as it goes. S&P didn’t take a position on how to apportion a deficit-cutting plan between tax increases and spending cuts. The firm seemed to blame Democrats and Republicans equally for hewing to their stock solution, which seems a little unfair, given that the GOP has been adamant about not raising taxes, and President Obama has at least paid lip service to the need for both higher taxes and lower spending.
In any case, this is a strange moment to be wringing one’s hands about partisan gridlock in Washington, since the glimmers of a debate on the deficit have just begun to emerge. S&P acknowledged that the release of a budget plan by the House GOP majority and President Obama’s response provide “the starting point of a process aimed at broader engagement.”
It’s true that the two camps are miles apart, since the GOP wants to eviscerate Medicare and save tax cuts for the wealthy, and Obama wants to preserve Medicare and return tax rates to pre-George Bush levels. But anyone who followed the 2008 and 2010 national elections must realize that two years is an eternity in politics — six months is an eternity.
The pointlessness of sticking one’s neck out on the imponderables of fiscal politics must be clear to S&P just now. After one-day slumps, Treasuries recovered and the stock market hit post-meltdown highs. The firm’s own S&P 500 stock index gained 2.5% for the rest of the week; it’s currently approaching three-year highs.
While it’s folly to draw any conclusions from short-term behavior of the investment markets, the stock market has been signaling expectations of appreciable growth in the U.S. economy for some time.
That’s important because the S&P analysts acknowledged that their forecast is very dependent on economic growth. (Their baseline forecast is for 3% annual real growth in gross domestic product, with an optimistic scenario of 4% and a pessimistic forecast of a one-year double-dip recession.) The higher the growth rate, the faster the deficit and debt burden become moderated.
S&P also observed that the U.S. remains one of the most economically dynamic nations on Earth, that its public sector is still smaller in proportion to its national income than those supposed paragons of fiscal wisdom, the U.K., France and Germany, and that to date the country’s fiscal uncertainties haven’t made a dent in the dollar’s position as the world’s leading international currency.
That’s economics, which is supposed to be Standard & Poor’s expertise. It should leave politics to someone else.
Michael Hiltzik’s column appears Sundays and Wednesdays. Reach him at firstname.lastname@example.org, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.