Who is Standard & Poor?

A company owned by Harold W. McGraw III, the Chairman, President and CEO of Standard & Poor’s parent corporation (McGraw-Hill) – thats who!  But whom shall I ask was the employee and supervisor that made the decision to downgrade our country’s credit rating?

On August 5, 2011, following enactment of the Budget Control Act of 2011, S&P lowered the US’s sovereign long-term credit rating from AAA to AA+. The press release sent with the decision said, in part:

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.

“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

“Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.”

The following day, S&P acknowleged in writing a USD$2 trillion error in its calculations, saying the error “had no impact on the rating decision” and:

“In taking a longer term horizon of 10 years, the U.S. net general government debt level with the current assumptions would be $20.1 trillion (85% of 2021 GDP). With the original assumptions, the debt level was projected to be $22.1 trillion (93% of 2021 GDP)

Some critics have pointed out that the company and other rating agencies were part of the cause of the global financial crisis of 2008–2009, for example when Moody’s downgraded Freddie Mac or, to quote Time, when “both agencies granted AAA rating to Collateralized Debt Obligations (CDOs) that were chock-full-of crap mortgages, thereby helping to precipitate the 2008 financial collapse”).  Ezra Klein wrote for The Washington Post that “Standard Poor’s didn’t just miss the bubble. They helped cause it”, but he said S&P took the right action to downgrade the U.S.  On the other hand, Paul Krugman wrote, “it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies”, and, “S&P’s demands suggest that it’s talking nonsense about the US fiscal situation.”  Consumer Credit Agency’s such as S&P have been subject to criticism in the wake of large losses beginning in 2007 in the collateralized debt obligation (CDO) market that occurred despite being assigned top ratings by the CRAs.

Credit ratings of AAA (the highest rating available) were given to large portions of even the riskiest pools of loans. Investors, trusting the low-risk profile that AAA implies, purchased large amounts of CDOs that later became unsellable. Those that could be sold often took staggering losses. For instance, losses on $340.7 million worth of CDOs issued by Credit Suisse Group added up to about $125 million, despite being rated AAA by S&P.  Companies pay S&P to rate their debt issues. As a result, some critics have contended that S&P is beholden to these issuers and that its ratings are not as objective as they should be.

The Big Three which includes Stand & Poor credit rating agencies’ breach of trust was at the core of our catastrophic economic contraction, helping bring our credit system to the brink of collapse. They massively and systemically over-rated certain types of securities – especially risky pools of bundled subprime mortgages and other debt – leading to false reliance on their safety. When the values of these securities cratered, investors lost hundreds of billions of dollars, helping to precipitate the credit system collapse.

In October, former Federal Reserve Chairman Alan Greenspan told Congress “unrealistically positive rating designations by the credit agencies was, in my judgment, the core of the problem,” referring to the economic meltdown.

With the US downgrade some have accused S&P of causing further damage for its own agenda. S&P acknowledged making a USD$2 trillion error in its justification for downgrading the US credit rating, but stated that it “had no impact on the rating decision”. “A judgment flawed by a $2 trillion error speaks for itself,” said a spokesman for the United States Department of the Treasury.

Another issue that has concerned commentators is that an S&P rating — for example, of the US government or any other world government — can have, and has had, a distinct effect on a truly global scale, but the decision on these ratings are made by the company’s employees who are not elected by the public, and are not accountable for their decision making process. There is no appeals process against a credit-rating decision.

The United States Department of the Treasury, which had first called S&P’s attention to its $2 trillion error in calculating the ten-year deficit reduction under the Budget Control Act commented, “The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raises fundamental questions about the credibility and integrity of S&P’s ratings action.

In November 2009, ten months after launching an investigation, the European Commission (EC) formally charged S&P with abusing its position as the sole provider of international securities identification codes for U.S.securities by requiring European financial firms and data vendors to pay licensing fees for their use. “This behavior amounts to unfair pricing,” the EC said in its statement of objections which lays the groundwork for an adverse finding against S&P. “The (numbers) are indispensable for a number of operations that financial institutions carry out – for instance, reporting to authorities or clearing and settlement – and cannot be substituted.”

S&P has run the CUSIP Service Bureau, the only International Securities Identification Number (ISIN) issuer in the US, on behalf of the American Bankers Association. In its formal statement of objections, the European Commission alleges “that S&P is abusing this monopoly position by enforcing the payment of licence fees for the use of US ISINs by (a) banks and other financial services providers in the EEA and (b) information service providers in the EEA.” It claims that comparable agencies elsewhere in the world either do not charge fees at all, or do so on the basis of distribution cost, rather than usage.

All in all, I have to ask the American people:  Are you comfortable with unnamed employees that work for a large corporation, which are capable of giving horrendous advice to Wall Street Bankers and our political leaders, as major players in the financial future of your country?  Are you satisfied that everyone from the Treasury Secretary and Chairman of the Fed which consult with Congressional and House leaders as well at the President of the United States uses their services to make decisions on your behalf?  This practice can create our own financial demise as well as that of the Global banking community. This faceless entity that no one can put a rope around the neck of.

Good Luck USA!

Brian Gray