Global Crisis/Innovation Blog

S&P: Substandard & Political — Why We Should Ignore Their “Alert” 

By Shlomo Maital

    David Beers, S&P sovereign debt rating head,  announced on Monday that “there is a risk of one in three, that within two years the rating of U.S. Government bonds will be lowered to AA from AAA”.  Within 30 minutes of this ‘alert’, the Dow Jones Stock Index dropped 200 points and stock prices fell all over the world.  It was the first time S&P had issued such an alert – note, it’s an ‘alert’, not an actual downgrade – since the Japanese bombed Pearl Harbor in 1941. 

   S&P stands for Standard & Poor.  It is one of three major bond-rating agencies, the others being Moody’s (which has Warren Buffett as an investor) and Fitch.  Neither of these two will change their AAA rating or even issue an alert.  Both experts and the general public have a very dim view of all three of  these agencies.   With the big banks as their main clients, they totally missed alerting us to the dangers of mortgage-backed bonds, backed by junk mortgages, until those bonds went into default in many cases.  Now S&P seeks to regain some credibility by warning it might downgrade US Treasury Bonds.  Its effort is Substandard and Political.

   Many regard Beers’ “alert” as political, in support of the Republican effort to slash government spending.  Republicans and Democrats remain divided on whether to cut the huge deficit by higher taxes or by lower spending.

   Frankly, S&P’s alert is ridiculous. America will never default on its US Treasury Bonds, and the bond market still regards them as the gold standard; immediately after Beers’ announcement, US bond prices went up, not down.  What is true is that America Inc. is a business, one that is very badly run. Among all the nations with debt crises, only the U.S. has no real emergency debt-reduction plan. (Japan too lacks one; but it is grappling with its disastrous earthquake).  On May 16, the US Govt. will reach its debt ceiling of $14.294 trillion !  If Congress fails to approve raising the statutory debt ceiling, the government will not be able to pay its bills. 

     There are strong signs that worldwide, inflation is rising. China in particular is troubled by it, and is tightening bank credit as a result.  A scenario far more plausible than S&P’s “one in three”  probability of a Treasury bond downgrade is that America will passively let inflation degrade the real value of its debt. This is how nations typically evade debt.   Meanwhile, the 2011 deficit of 1.6 trillion dollars is staggering, but will decline sharply in future years.   Only 19 out of 127 sovereign nations whose bonds are rated by S&P get AAA; the U.S. is probably still the safest of the 19.

     Roiling global markets, and making political statements, is not the mission of S&P.  Let them stick to their knitting, providing us with transparent information so informed investors can make their own judgment.  The enormous pressure on S&P to bestow AAA ratings (a precondition for many pension funds to buy them) will forever make us skeptical about anything S&P says or does.  In the end, as with everything, it’s all about money.