Is S&P’s decision unfounded?

S&P’s decision is still subject to huge controversy. According to Warren Buffet who is the main shareholder of Moody’s, a competitor of S&P which has maintained its AAA rating of the USA, this decision can be described as “pure madness”. Mister Buffet contends that the USA deserves a quadruple A rating considering the fact that the T-Note remains the most sought after debt security in the world. He goes further by saying that the only consequences of S&P’s decision will be an extension of the drop in equity markets and a growing risk for a new recession which was nonexistent until now.

Several central banks have indicated that this downgrade will not impact their policies regarding investments in American debt securities. The Japanese central bank, the ECB and the Russian central bank have declared that they will maintain their T-Note investments and that there would be no change in the amounts allocated to banks bringing American debt securities as collateral.

John Bellows, the deputy treasury secretary, has highlighted a 2000 billion dollar error from S&P in his blog and laments the fact that the rating agency did not review its decision. He also complains that S&P did not take an additional day to reevaluate its analysis. Mister Bellows added that the size of the error and the speed with which S&P changed its main justification when confronted with this error create major doubts on the credibility and integrity of the rating agency regarding the decision to downgrade the United States.

Paul Krugman, an economics Nobel prize winner, considers that S&P analysts are in no position to judge the creditworthiness of the United States. He reminds the staggering amount of AAA ratings distributed by S&P and its competitors to evaluate “toxic” financial products which subsequently caused the worldwide crisis during the fall of 2008. Robert Reich, the former employment secretary in Bill Clinton’s cabinet, supports this view. He writes in his blog that S&P’s intervention is highly ironic since a large part of America’s current debt is directly or indirectly the result of S&P’s failures.

Europe arrives to the same conclusions! In an interview given last Sunday to the Spanish newspaper La Voz de Galicia, José Manuel Gonzalez Paramo who is a member of the ECB executive council argues that the three main rating agencies face huge conflicting interests and that greater competition in the rating agencies’ sector is required to improve efficiency. He went further by saying that there is a big problem with rating agencies in that they can be bad or very bad in their recommendations as demonstrated during the past few years and that they do not take their responsibilities.

Bill Miller, Chief Investment Officer of Legg Mason Capital Management wrote : "The downgrading by Standard & Poor’s of the credit rating of the United States was precipitous, wrong, and dangerous. At best, S&P showed a stunning ignorance and complete disregard for the potential consequences of its actions on a fragile global financial system" According to him, There was no need for S&P to rush to judgment just days after a bruising political battle had secured a bipartisan agreement to raise the debt ceiling through the next election cycle and which initiated a process to begin to cut spending and address the nation’s long term fiscal imbalances.

There are at least three reasons why S&P was wrong to downgrade.
 The contentious debate surrounding the debt ceiling succeeded in doing something important that had not been done before
 S&P apparently gave little or no weight, or certainly insufficient weight, to the unique role the United States plays in the global economy
 The market says S&P is wrong. The US enjoys among the lowest interest rates in its history coincident with the highest deficits and a daunting long term fiscal outlook. Yet when investors in a highly uncertain world are looking for safe assets, they invest in US Treasuries.

Mohammed El-Erian, the CEO of Pimco, says that S&P’s decision will fuel uncertainty on the world’s economy core functioning since no other AAA country can replace the USA as the center of the world’s financial system. This appears to be quite a paradox since Bill Gross, the founder of Pimco, the world’s biggest bond manager, had previously indicated that he had given up any involvement in American debt because of the state of the country’s finances.

According to Claran O’Hagan, a fixed income strategist at Société Générale, this decision will have severe consequences even if it was partly predictable. He fears that a Pandora box may have been opened as a result. Mister O’Hagan believes that the downgrade will slightly impact risk free assets but that the biggest reaction will be on equities and on agency securities directly secured by the Federal government.