Is Standard and Poor's Manipulating US Debt Rating to Escape Liability for the Mortgage Crisis?

The Politico headline says it all:

U.S. credit downgrade worries Obama, Congress more than default

It's not the default that strikes the most fear in the White House and Congress these days. It's the downgrade

The Politico headline says it all:

U.S. credit downgrade worries Obama, Congress more than default

It's not the default that strikes the most fear in the White House and Congress these days. It's the downgrade

As Robert Reich notes, Standard and Poors is the "biggest driver in the deficit battle." Why would anyone care what the corrupt and disgraced organizations who quite nearly brought down the world economy think about anything at this point? And yet, that is where elite opinion is focused right now:

[W]hat really haunts the administration is the very real prospect, stoked two weeks ago by Standard & Poor's, that Barack Obama could go down in history as the president who presided over his country's loss of its gold-plated, triple-A bond rating.


Financial analysts say such a move would hit Americans with more than $100 billion a year in higher borrowing costs, but it's not just that. It would be a psychic blow to a nation that already looks over its shoulder at rising economic powers like China and wonders, what's gone wrong? And it would give the president's Republican rivals a ready-made line of attack that he's dragging the country in the wrong direction.

This rumbling has been coming from Capitol Hill for a while, which made us start asking questions about what was really going on with Standard and Poors. It felt like there's a story-behind-the-story driving S&P's actions in the debt ceiling debate, which appear inexplicable at face value and go way beyond what Moody's or Fitch have done. And the more we looked at the timeline of events, the more we wondered how the intertwining dramas of a) S&P downgrade threats, b) the liability that the ratings agencies may have for their role in the 2008 financial meltdown, and c) the GOP's attempts to insulate the ratings agencies from b) are all impacting each other.

Timeline of Events

On July 21, 2010 President Obama signs Dodd-Frank into law. Prior to Dodd-Frank, the courts found that credit ratings are expressions of opinion that were protected under the first amendment, subject to a demonstration of actual malice:

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.

Which, for obvious reasons, made the ratings agencies extremely nervous.

In October 2010, S&P issues its first threat to downgrade US debt: "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." The report paints a target on the back of Social Security and Medicare, says nothing about the wars, the Bush tax cuts, private health care costs or the absurdity of 40 year projections.

Ratings agencies are supposed to be reactive and analyze only what they see. They are not supposed to explicitly or implicitly give "assurance or guarantee of a particular rating prior to a rating assessment." By prescribing not only an austerity package for the United States, but stating that "in the long term, the U.S. AAA rating relies on reforms" of Social Security and Medicare, they most assuredly broke that rule.

S&P put forth no legitimate basis for their downgrade threat. As every reputable economist keeps reminding us (James K. Galbraith, Joe Stiglitz, FT's Martin Wolf, Peter Radford, Bruce Bartlett, Krugman), the US is not Greece and does not face its risk of default. Unlike Greece, the US has its own currency, and unlike Greece, its debt is denominated and would be paid in its own currency. It can create that currency at will. So the only way the US can be forced into default is if Congress and the President do something that would be insane, like refuse to raise the debt limit, and the President then refuse to use the Executive authority of the Constitution to prevent a default.

But S&P was clearly determined to set itself up as arbiter of the US debt ceiling debate. They said nothing in December when the Bush tax cuts were extended, which dramatically exacerbated the deficit problem they warned of in October. But on February 14 President Obama releases his budget, which cut the deficit by $1.1 trillion over 10 years. The Standard and Poors committee found Obama proposal "disappointing."

Sign our petition to the SEC: Revoke S&P's authority as a credit ratings agency for their use of ratings as a political weapon and their attempts to avoid responsibility for their role in the financial crisis of 2008.

The White House clearly began to worry about the political implications of what S&P might do. Emails from both Treasury and S&P were provided to the House Financial Services committee earlier this week, showing that in March S&P and Treasury officials began coordinating discussions of the administration's budget strategy before the S&P committee met to discuss the US credit rating.

But White House officials weren't the only ones trying to work the refs. On March 14 Congressional Republicans stage their first challenge to 2010's Dodd-Frank financial regulation reforms -- an attempt to repeal the provision exposing credit rating agencies to the legal liability they were chafing to escape from.

And on April 5 Paul Ryan announced his alternative budget plan. Ryan's budget was claimed (it was mostly a fraud) to produce over $4 trillion in reductions, while reducing tax rates. It also did so by slashing Medicare and making hundreds of billions in unspecified cuts to unnamed domestic programs. S&P were conspicuously silent.

April 13 was a big day

President Obama gave a speech in which he vowed to cut $4 trillion in cumulative deficits within 12 years through a combination of spending cuts and tax increases. Why was he suddenly pursuing $4 trillion in cuts, up from $1.1 trillion in January? Clearly Ryan had upped the ante. But what was he competing for?

Also on April 13, Timothy Geithner along with Deputy Secretary Wolin, OMB Director Lew and a representative of the vice president's office met with S&P personnel, per Geithner's June 13 letter to the House Financial Services subcommittee. ABC reported that Geithner asked S&P's David Beers to hold off on issuing any report until after the President Obama and Congress had completed negotiating over the rest of the FY2011 budget.

But perhaps the biggest thing that happened on April 13: A bipartisan study on the financial crisis from the Coburn-Levin Senate Permanent Subcommittee on Investigations released a report saying the credit ratings agencies were a "key cause" of the financial crisis. They issued a 650 page report, which included the following recommendation (p. 16):

The SEC should use its regulatory authority to facilitate the ability of investors to hold credit ratings 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.

Two days later, David Beers reached out to Undersecretary Goldstein to let Treasury know that the Standard and Poors committee has changed its outlook to "negative." On April 18: Standard and Poors issued press release downgrading the outlook for US sovereign debt from stable to negative and giving a 30% chance of a ratings downgrade from AAA to AA.

"U.S.'s fiscal profile has deteriorated steadily during the past decade and two years after the financial crisis" they say -- with no mention of their own role in that crisis. And whereas the October threat had been based on concerns over Social Security and Medicare, the latest press release contained no mention of either. Now they were worried that "Republicans and Democrats are deeply divided on a plan to reduce debt" and that political squabbling will prevent the debt ceiling from being raised.

On April 19 Geither was dispatched to do an exhaustive round of talk shows, saying he disagrees with Standard and Poors and that there is "no risk" of a credit ratings downgrade.

But Geithner isn't the only one. On April 20 Mitt Romney begins using the S&P threat of a downgrade for political advantage. In a radio interview he says that S&P "just downgraded their view for the future of America" and called for the President to "sit down and personally meet with S&P" as he said he did as governor of Massachusetts.

SEC takes the gloves off

In the midst of all of this, the SEC was moving to implement Dodd-Frank in ways that would negatively impact all the ratings agencies, and looking into S&P's role in the 2008 mortgage crisis:

  • May 18: the SEC commissioners "voted unanimously to propose new, tougher regulations for credit rating agencies," which would "implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC's existing rules governing credit ratings."
  • June 9: Bloomberg reports the SEC may recommend recommend that ratings agencies be prohibited from advising investment banks on how to earn top rankings for asset- backed securities
  • June 14: Reports emerge that the SEC is considering civil fraud charges against S&P and Moody's in the run up to the financial crisis.

But Standard and Poors was not cowed by the SEC's sudden rash of action. On July 14 they raised the threat of a downgrade to 50% within the next 90 days.

And now they were very explicit about what they were looking for in exchange for a AAA rating. They wanted a number... which just happened to be the magic $4 trillion number:

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.

Incredibly, S&P's Devan Sharma told Congress this week that that S&P had been "misquoted" regarding the $4 trillion figure and that it had been "inaccurately stated that the company was calling for that specific threshold." I really don't know any other way you could read it. He also accused the administration of "meddling in the ratings process," a charge quickly trumpeted by Republicans on the committee.

Politico reported that administration officials were "shocked by the move," suggesting that it did not seem to square with prior S&P reports (duh).

But S&P wasn't done. On July 21: David Beers met with Congressional Republicans in a closed door meeting to brief them on a potential downgrade of US debt.

And on that same day, the House Financial Services Committee approved the bill to remove the Dodd-Frank provisions that subject credit ratings agencies to expert liability. It passed 31-19 "over the opposition of the senior Democrat on the panel," devolving into a clear partisan effort.

Then on Tuesday of this week, the SEC unanimously approved a plan to erase references to credit ratings from certain rulebooks. They also adopted alternatives to the credit ratings -- a blow to the CRA's entire business model.


It's becoming more and more obvious that Standard and Poor's has a political agenda riding on the notion that the US is at risk of default on its debt based on some arbitrary limit to the debt-to-GDP ratio. There is no sound basis for that limit, or for S&P's insistence on at least a $4 trillion down payment on debt reduction, any more than there is for the crackpot notion that a non-crazy US can be forced to default on its debt.

Whatever S&P's agenda, it has nothing to do with avoiding default risks or putting the US on sound fiscal footing. It appears to be intertwined with their attempts to absolve themselves from responsibility for their role in the 2008 financial crisis, and they are willing to manipulate not only the 2012 election but the world economy to escape the SEC's attempts to regulate them.

It's time the media and Congress started asking Standard and Poors what their political agenda is and whom it serves.

Sign our petition to the SEC: Revoke S&P's authority as a credit ratings agency for their use of ratings as a political weapon and their attempts to avoid responsibility for their role in the financial crisis of 2008.

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