Treasury Hits Back Against S&P’s Historic Downgrade

The Treasury hit back against Standard & Poor’s historic downgrade of the U.S. to AA+ from its top-notch AAA by lashing out against its credibility, as well as its judgment.

In a Saturday blog post on Treasury’s website entitled “Just the Facts: S&P’s $2 Trillion Mistake,” John Bellows, Treasury’s Acting Assistant Secretary for Economic Policy, says S&P “presented a judgment about the credit rating of the U.S. that was based on a $2 trillion mistake.”

Bellows says the error raises “fundamental questions about the credibility and integrity of S&P’s ratings action.”

White House adviser Gene Sperling adds: “The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in their press release once the error was pointed out was breathtaking.”

The “error” is largely a difference of opinion on what growth rate to use to calculate how fast government spending on discretionary programs will grow over the next decade, either expected GDP growth rates, or inflation rates.

S&P used GDP growth estimates of 5%, meaning, spending would grow 5% annually over the next ten years, or $1.8 trillion.

But Treasury says using the lower inflation rate results in lower spending projections. The rates in use here come from the bipartisan Congressional Budget Office. Supporting Treasury here is the fact that U.S. GDP growth is now averaging around 2% for 2011.

Bellows says S&P’s approach caused it to “dramatically overstate projected deficits—by $2 trillion over 10 years.”

Noting that Treasury had pointed out to S&P this “basic math error of significant consequence,” Bellow says “S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.” Rich Edson, FOX Business’s Washington, D.C. correspondent, obtained the Treasury post and has been breaking news on D.C.’s reaction to the downgrade.

After admitting to the error, S&P put out a statement saying that, regardless, its downgrade was based on the creditworthiness of U.S. debt over a three- to five-year time frame, whereas Treasury’s outlook for government debt is based on a 10-year period.

S&P in the statement released early Saturday morning said the $2 trillion math error did not alter its decision to downgrade. S&P says it had consulted its sovereign ratings officials in Europe before announcing the downgrade after the market’s close.

It says by 2015 U.S. debt reaches an untenable 79% of GDP—and it says using Treasury’s approach makes a nominal difference of just two percentage points by 2015, to a debt to GDP ratio of 81%, or $345 billion. S&P is also demanding at least $4 trillion in deficit reductions over the next decade, saying in its downgrade statement that the $4 trillion must be arrived at via cuts or revenue increases.

S&P’s downgrade is expected to affect borrowing costs for government, business and consumers by possibly raising them higher by 0.7% or more, at a time when the U.S. economy ground to a halt in the first half and average annual economic growth is trending below 2% for 2011.

U.S. 10-year Treasuries fell below 3% to settle at 2.6%in Friday’s trading, as investors fled the turmoil in Europe, which means a question mark hangs over how much borrowing costs could rise given the downgrade.

S&P also kept U.S. debt on a credit negative outlook, as it is concerned the “acrimonious” fighting in Washington has created “political gridlock,” thwarting meaning deficit reductions. Moody’s Investors Service and Fitch Ratings reaffirmed their AAA rating for the U.S. Aug. 2, the day President Barack Obama signed the debt ceiling increase into law, avoiding default.

The math error, along with S&P’s decision to include U.S. state and local debt in its decision to downgrade, when state and local governments can cut or tax their way to fiscal health, are part of the controversial back story to S&P’s historic move.

Treasury’s Bellows attacks S&P’s credibility, by first setting up the fact that that S&P does consider a $2 trillion swing significant.

He says its “decision to downgrade the U.S. was based in part on the fact that the Budget Control Act, which will reduce projected deficits by more than $2 trillion over the next 10 years, fell short of their $4 trillion expectation for deficit reduction.”

Bellows added: “Clearly, in that context, S&P considers a $2 trillion change to projected deficits to be very significant.”

Bellows says “S&P’s $2 trillion mistake led to a very misleading picture of debt sustainability – the foundation for their initial judgment. This mistake undermined the economic justification for S&P’s credit rating decision.

“S&P took the amount of deficit reduction CBO calculated from the Budget Control Act and applied it to the wrong starting point, or ‘baseline,’” Bellows says.

The CBO had calculated that the new Budget Control Act, which accompanied the increase in the debt ceiling, would actually save $2.1 trillion over ten years.

Again, this is key. The baseline used here assumes the government’s spending on discretionary programs grows at the rate of inflation, which is lower than the CBO’s expected GDP growth of 5% average over the next decade.

Bellows says “S&P incorrectly added that same $2.1 trillion in deficit reduction to an entirely different ‘baseline’ where discretionary funding levels grow [instead] with the [rate of] nominal GDP [growth] over the next 10 years.”

Bellows note that the GDP growth rate “is substantially higher because CBO assumes that nominal GDP grows by just under 5% a year on average, while inflation is around 2.5% a year on average.”

Again, backing Bellows up is the fact that U.S. GDP growth is now averaging around 2% for 2011.

Using instead this alternative ‘baseline’ built on GDP growth, not the rate of inflation, caused S&P to erroneously, and “dramatically overstate projected deficits—by $2 trillion over 10 years,” says Bellows.

Treasury is sticking fast with its $4 trillion in expected cuts over ten years.

“The Budget Control Act will save more than $4 trillion over ten years – or over $2 trillion more than S&P calculated,” Bellow says.

Treasury’s Bellows addeded that after S&P corrected its mistake, the fix “lowered S&P’s projection of future deficits by $2 trillion over 10 years and lowered S&P’s estimate of debt as a share of GDP in 2021 by eight percentage points,” showing U.S. “public debt is much more stable.”

Bellows says “a change of this magnitude is very significant. Nonetheless, S&P did not believe a mistake of this magnitude was significant enough to warrant reconsidering their judgment, or even significant enough to warrant another day to carefully re-evaluate their analysis.”

Bellows adds “S&P acknowledged this error – in private conversations with Treasury on Friday afternoon and then publicly early Saturday morning. In the interim, they chose to issue a downgrade of the US credit rating.”

He says: “Independent of this error, there is no justifiable rationale for downgrading the debt of the United States. There are millions of investors around the globe that trade Treasury securities.”
Bellows says: “They assess our creditworthiness every minute of every day, and their collective judgment is that the U.S. has the means and political will to make good on its obligations. The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raise fundamental questions about the credibility and integrity of S&P’s ratings action.”

S&P’s downgrade straitjackets the Administration’s desire to do more stimulus spending as other government attempts at boosting the economy, including the first $800 billion stimulus program as well as extended unemployment benefits, among other items, vanish by the time the 2012 re-election year rolls around.

Meanwhile, the jobless rate still remains stubbornly high at 9.1%.

S&P chief of the U.S. sovereign ratings committee John Chambers also tells FOX Business’s Neil Cavuto that the U.S. faces a further downgrade to AA “in six months to 24 months time” if the government doesn’t present least $4 trillion in deficit reductions over a 10-year period, or if rates rise, or if the government faces “new fiscal pressures.”

S&P says such fosca; pressures are expected to arise due to teetering entitlement programs such as Medicare, as the baby boomers are set to retire en masse.

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About Elizabeth MacDonald 7 Articles

Affiliation: FOX Business Network

Prior to joining FBN, MacDonald was a senior editor at Forbes Magazine, where she covered stock market and earnings news and created "The World's 100 Most Powerful Women" annual list. She was also a regular guest on the FOX News Channel (FNC), appearing on "Forbes on Fox," "Your World with Neil Cavuto" and "The O'Reilly Factor."

Before Forbes, MacDonald covered stock market, earnings and accounting abuses for The Wall Street Journal's Money & Investing section, with front page stories and Heard on the Street columns. MacDonald was one of the first journalists in the country to sound the alarm about the coming wave of accounting scandals in the mid-nineties, and also broke stories on, for example, Scientology's secret settlement with the IRS and the Kennedys' use of the IRS to target political enemies.

Prior to that, MacDonald was a financial editor for Worth magazine and covered the IRS and taxes for Money magazine. Members of Congress have noted an award-winning investigative series MacDonald reported on IRS abuses led to improved taxpayer rights and reforms at the agency. MacDonald was also called in to testify before Congress about IRS abuses.

Recognized as one of the top prize-winning business journalists in the country, MacDonald has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism (and won a nomination in an ensuing year); the Society of Professional Journalists' Award for Outstanding Public Service reporting; and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

MacDonald is a native of Rockville Centre, New York.

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