S&P under Fire for Ratings Downgrade

Ratings agency Standard and Poor’s is suffering the wrath of the federal government and some wealthy investors who have remarked that the agency is in the wrong after …

Ratings agency Standard and Poor’s is suffering the wrath of the federal government and some wealthy investors who have remarked that the agency is in the wrong after downgrading the U.S. from a AAA credit rating to a AA+. This was predicted by analysts who identify the source of negative comments as those with the most to lose in terms of reputation and money. Other economists, however, say S&P did the right thing in sending a message to U.S. policy makers to clean up their act, even if it did make a $2 trillion accounting error in its assessment. The question for investors may be what is more important: the math or the message. For more on this continue reading the following article from The Street.

Standard & Poor’s historic downgrade of U.S. debt was a calculated move by the credit-rating agency to get out in front of a growing debt problem. But instead, the rating cut has become a game of shoot the messenger, leaving individual investors to question which is more credible now: S&P or the U.S. government?

On Friday, S&P lowered its long-term sovereign credit rating on the U.S. to AA+ from AAA and affirmed the A-1+ short-term rating, marking the first time the country’s rating has ever been lowered. S&P, which is a segment of McGraw-Hill(MHP), said the outlook on the long-term rating is negative, and the rating could suffer another downgrade within the next two years.

Before the release was made official late Friday, the credibility of S&P’s move was undermined when White House and Treasury sources told several media outlets that the credit-rating firm made a $2 trillion math error and that it was “amateur hour.” The downgrade came anyway, and politicians and market pundits spent the entire weekend blasting the S&P. S&P was forced to later issue a clarification on assumptions its analysts used on discretionary spending growth.

Rather than heed the message that the “effectiveness, stability, and predictability of American policymaking and political institutions” had weakened, observers immediately attacked S&P for its past mistakes in rating collateralized debt obligations, or CDOs, during the housing crisis.

Minutes after the downgrade was officially announced, the attacks on S&P began. Paul Krugman wrote on The New York Times Web site that “it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?”

Treasury Secretary Tim Geithner, in an interview Sunday with CNBC, said S&P “has shown really terrible judgment and they’ve handled themselves very poorly. And they’ve shown a stunning lack of knowledge about basic U.S. fiscal budget math. And I think they drew exactly the wrong conclusion from this budget agreement.”

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Billionaire investor Warren Buffett stepped into the fray, arguing that the U.S. actually deserves a quadruple-A rating rather than a downgrade, ignoring the fact that a quadruple-A rating doesn’t exist. “If anything, [the downgrade] may change my opinion on S&P,” Buffett said to CNBC, adding that he would even buy U.S. Treasuries that yield nothing if he had to do it.

Buffett found an ally in another legendary investor, Legg Mason’s Bill Miller, who called S&P’s decision “precipitous, wrong, and dangerous.”

“The disastrously flawed ratings of these agencies were at the heart of the financial crisis of 2008, and this unilateral action by S&P threatens to create mayhem yet again in the system by creating uncertainty about the ability of the United States to function in its unique and critical role in the global financial system,” Miller wrote in a Sunday letter.

For all the energy expended discrediting S&P and its conclusion on the U.S. debt situation, other politicians gave credence to the S&P downgrade by using it as weapon against the other party. During appearances on Meet the Press Sunday, Sen. John Kerry (D-Mass.) called it a “Tea Party downgrade,” while Sen. John McCain (R-Ariz.) countered by attacking President Obama and noting that Republicans control only one-third of the government. Ironically, the same vitriol S&P warned against now involves the downgrade of the triple-A rating.

For investors, the learning process of what the downgrade of U.S. debt really means has been an excruciatingly painful one. U.S. equity indices fell between 3% and 4% before midday Monday. As the bickering across the aisle has continued so have the attempts to discredit S&P. Discerning who to believe is an unenviable task for U.S. investors.

“The bickering highlights the fact that the U.S. is in a precarious state,” says Robert Pavlik, chief market strategist with Banyan Partners. While he questions S&P’s authority in sending a message to Washington over the rising debt levels, Pavlik makes the analogy that S&P is now acting like a parent sick of hearing its two children whining, crying and arguing for far too long.

“The message had to be received out there. I just didn’t know that S&P is the parental figure in charge,” Pavlik says. “All you’re going to get is negative, nasty comments. Who’s fault is it? It’s our fault. It’s the entire U.S. behind it. If you want to point the finger, you have to point it at yourself. The argument over whether this is a Democrat or Republican thing is wrong. Everyone is culpable. It’s time to take on the responsibility and ownership.”

Other professional investors stepped up to defend the S&P’s downgrade. Bill Gross, manager of the world’s largest bond fund at Pimco, told Bloomberg that S&P “has demonstrated some spine; they finally got it right.”

“What Standard and Poor’s is trying to accomplish is to warn the U.S. to get its deficit, which is growing at 10% of GDP, down in the low single digits as soon as possible. For that they should be congratulated and not vilified,” Michael Pento, senior economist with Euro Pacific Capital, wrote in an email Monday. “After getting so much wrong, they are making an honest effort to get something right.”

Jeffrey Sica, president and chief investment officer of Morristown, N.J.-based Sica Wealth Management, predicted on Saturday that individual investors would witness a “tremendous effort to discredit S&P” this week. He says that while S&P and other ratings agencies have lost a lot of credibility, this is not the same S&P from during the housing crisis.

“S&P has done enough to discredit themselves in 2008,” Sica said by phone late Saturday. “I think an effort by government and the banks to discredit them more will backfire. People will see it’s coming from the government that got us to a depressing point.”

For now, it appears the jury is still out over whether to believe the government or S&P. U.S. Treasuries — the same ones essentially downgraded by S&P — continue to be bought up by investors, as the yield has dropped below 2.40% on the 10-year. The equity markets, on the other hand, continue to sink, with the Dow Jones Industrial Average and S&P 500 down 8.5% and 10.6%, respectively, in August alone.

This article was republished with permission from The Street.

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