The deal to raise the debt ceiling struck between Democrats and Republican marked a new low in an already shallow pool. The US economy was literally held hostage in order to extract concessions. The threat of a looming US default and the ensuing ratings downgrade was leveraged to enact spending cuts well beyond what Democrats considered acceptable. The final agreement left both sides unhappy - normally the sign of a fair deal - but for unusual reasons. Democrats were aghast by tactics that bore closest resemblance to extortion; Republicans were upset they hadn't asked for more.
I knew that the latest low-water mark for Washington would be short lived. How long until the possibility of a government shutdown was raised? How long before the specter of another debt ceiling raise returned? Would the threat of a FAA lockdown be leveraged into another unpleasant 'compromise'?
I just didn't expect the next shakedown to come so quickly, or to be so brazen.
On Friday Standard and Poor’s downgraded USA's triple-A credit rating to AA+, the first downgrade in US history. In their explanation they took shots at both Republicans and Democrats, painting blame on congress in whole instead of either party. Republicans refuse to even consider tax raises, they mused, while Democrats are loathe to touch Medicare and entitlements.
Make no mistake - hidden under all the boilerplate conventional wisdom was not a credit ratings agency exasperated by gridlock in Washington. This was a credit ratings agency actively trying to enforce policy, trying to throw influence around in an effort to get its way.
Word is out - Washington is open for business and the crooks with hands in the tiller don't even have the decency to wait until nightfall to commit their crimes.
This isn't exactly a huge shock. S&P has been consistent, far more consistent than any politician in Washington. Here was the first warning shot, fired back in October of 2010.
In the Long Term, The U.S. 'AAA' Rating Relies On Reforms
If the U.S. government maintains its current policies for the next 40 years in the face of rising health care and pension spending pressure, it is unlikely that Standard & Poor's Ratings Services would maintain its 'AAA' rating on the U.S. Treasury. We are keeping the rating at 'AAA', with a stable outlook, because the typical rating horizon is three to five years, and the demographic and other drivers (such as health care inflation) of long-term increases in age-related expenditure that we highlighted in our study are unlikely to have an impact on the rating in that timeframe.
Notice that S&P isn't just rating the country's credit risk rating but instead actively advocating a solution. That goes far beyond their job description and might have raised a few eyebrows at the time. Why, exactly, would a credit ratings agency go so far, be so aggressive?
The Dodd-Frank financial reform act was signed into law July 21, 2010 - just over two months before S&P came out swinging. Included in Dodd-Frank was this gem:
The Dodd-Frank Financial Reform Act stripped away those protections, so that CRA’s were now subject to the same expert liability as an auditor or securities analyst, and required only a “knowing” or “reckless” state of mind for liability, rather than proof of scienter. It also repealed Section 436 of the Securities Act of 1933, which granted “safe harbor” for ratings, which were part of a prospectus.
I'm sure you remember how well S&P acquitted itself during the financial meltdown of 2007. They were busy pumping out AAA ratings to some of the riskiest securities and debt obligations until the very last minute. The financial meltdown attracted a lot of eyes on CRA's and resulted in a law to hold them accountable in case their ratings proved to be wildly unrealistic.
Worse still was the report from a bipartisan subcommittee investigation into the financial crisis. Included in the 652 page report were many shocking indictments of CRA's and calls for the SEC to increase regulation on them.
The SEC should use its regulatory authority to facilitate the ability of investors to hold credit rating agencies accountable in civil lawsuits for inflated credit ratings, when a credit rating agency knowingly or recklessly fails to conduct a reasonable investigation of the rated security.
The SEC should use its inspection, examination, and regulatory authority to ensure credit rating agencies institute internal controls, credit rating methodologies, and employee conflict of interest safeguards that advance rating accuracy.
The SEC should use its inspection, examination, and regulatory authority to ensure credit rating agencies assign higher risk to financial instruments whose performance cannot be reliably predicted due to their novelty or complexity, or that rely on assets from parties with a record for issuing poor quality assets.
In other words the CRA's were out of control and needed to be reined in. How did S&P respond to such scathing accusations? Less than a week after the senate released its 650 page report S&P ran to the press and downgraded the USA's credit outlook from stable to negative.
They didn't stop there. Instead of backing down, S&P went on the offensive. S&P wasn't alone in threatening to downgrade the US if a deal was not met to raise the debt ceiling but they alone had the dubious distinction of threatening a downgrade if a finalized deal was not to their liking.
If Congress and the Administration reach an agreement of about $4 trillion, and if we to conclude that such an agreement would be enacted and maintained throughout the decade, we could, other things unchanged, affirm the ‘AAA’ long-term rating and A-1+ short-term ratings on the U.S.
In other words - go big or go home. A 4 trillion deal is notable because it was larger than one being discussed by either Boehner or Reid. As I've pointed out above, S&P had already outlined where they wanted the reforms to come from. Now they were laying out their price.
Again, this isn't a credit ratings agency doing diligence to the markets and downgrading because of risk or uncertainty. This is S&P following the GOP's lead and trying to exert pressure on Obama and Washington. Out with the Information Age, in with the Extortion Age!
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/Robert Reich has an excellent article up on how big a player S&P was during the debt ceiling fight.