Why should we trust S&P anyway?

The agency is under the microscope after downgrading the US credit rating. After its spotty track record, should its opinions matter?

By Kim Peterson Aug 10, 2011 2:48PM
It's been nearly a week since Standard & Poor's downgraded the U.S. credit rating, and the agency is still receiving plenty of criticism.

Is it warranted? Should we trust S&P, which, along with other ratings agencies, maintained Enron's top AAA credit rating even as the company spiraled toward bankruptcy? By S&P's standards, Enron was more likely to pay its debts than the U.S. This is the same S&P that slapped a perfect rating on those mortgage securities backed by high-risk loans that helped plunge the U.S. into financial crisis.

Politicians and regulators have jumped all over S&P for its actions, saying the agency's track record clearly shows it's out of its league when it comes to understanding debt.

Remember that S&P made a $2 trillion boo-boo in its calculations about U.S. deficits -- and then went ahead with the downgrade anyway. One financial executive even hired a plane to fly over S&P's offices with a huge banner that said: "Thanks for the downgrade. You should all be fired."

By the way, lots of people are talking about MSNBC anchor Dylan Ratigan's tirade against Republicans, Democrats and the financial system in the following video.

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To understand S&P, it's necessary to first look at what the agency does and then check its track record. To start with, it doesn't measure the same thing as chief rival Moody's, as Reuters' Felix Salmon points out.

S&P only measures the probability of debt default, while Moody's tries to measure expected losses in a default. That's likely why Moody's maintained its rating: Even if the U.S. did default, it would likely only be temporary and bondholders would get repaid eventually, Salmon writes.

So how well does S&P do at this game? Not that well, as Nate Silver at FiveThirtyEight discovers. That's partly because S&P places heavy emphasis on a country's internal politics in making its rating. In fact, political factors are just as important as economic for the agency.

S&P ratings are strongly tied to a company's Corruption Perceptions Index, which is formed using surveys from "experts" at international organizations who may not even live in the country being analyzed, Silver writes.

Further, there's little evidence that S&P's ratings perform well, Silver writes. S&P's ratings from five years ago showed the agency had no clue about the world's economic environment today. Ireland and Spain had perfect AAA ratings, for example, and their debt is quite risky.

In fact, Silver notes, you might be better off betting against S&P's judgments as a general rule:
Relying on the consensus of the market is almost certainly better than relying on Standard & Poor’s, whose advice has more often than not led investors toward the losing side of bets. The fact that billions of dollars in wealth are tied up in the judgments of a company with such a poor record is all the proof you should require that the global financial system is in need of reform.

Standard & Poor's is defending itself, saying its job is to put its research out there, and investors can decide whether to agree or not. "No issuer of debt welcomes or is happy with a downgrade by us," the head of S&P's sovereign ratings group told Reuters. "And as you know, we're no strangers to attacks by governments when we downgrade sovereign debt ratings."

In other words, S&P says, bring it on. And that's exactly what politicians are now doing. "I am deeply disappointed in S&P’s decision to enter into the game of political punditry," said Tim Johnson, the Democrat who heads the Senate banking committee, according to the Financial Times. He called the downgrade "irresponsible," and said it could ultimately tax Americans by raising interest rates.

Regulators are joining the criticism. Treasury Secretary Tim Geithner said S&P "has shown really terrible judgment and they've handled themselves very poorly." Ouch.

Now, the Securities and Exchange Commission is suggesting that S&P and other agencies disclose any significant errors they make when calculating their ratings. S&P is pushing back, saying that it already has an error correction policy, and it responds quickly when it uncovers any mistakes.

That isn't enough for Barbara Roper, the director of investor production for the Consumer Federation of America.

"What was their correction policy on their Enron rating?," she said, according to Reuters. "What was their correction policy on their Lehman rating? What was their correction policy on their Bear Stearns rating? They don't have an error correction policy -- they have an error denial policy, and the SEC is absolutely right to step in."

But there's one important point to remember in all this scrutiny of the S&P: Don't overlook the agency's legitimate concerns about the economy and Washington's inability to agree on a credible fix for the budget or the deficit.

"If at this point, in response to this news, a commentator attacks the ratings agencies for their previous mistakes and stupid, corrupt behavior, it’s a sign the commentator is trying to muddy the broader issues at stake," wrote economist Tyler Cowen. "Such commentators may well be correct in their criticisms, but probably they are not facing up to their recent mistakes and seeking to shift the blame."
7Comments
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I don't trust the S & P.  Because of the recent downgrade, and also because of their Trillion dollar math error.  Another reason that I think that they have lost THEIR credibility is because THEY gave many of the "Toxic Mortgage Companies" a triple A  rating up until the DAY those Companies went  BK....wondering who they are giving campaign contributions too?  Mysterious companies that open and close within a matter of months.  Strange DEALINGS INDEED!!!

Aug 10, 2011 4:13PM
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Michele....I agree with you.....Globally people have placed way too much credence on what S&P has done with ratings. They totally missed the housing debacle and the credit default swap nightmare so why would anyone care about their downgrades. People are certainly in panic mode and need to chill.
Aug 11, 2011 10:27AM
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Why would anyone accept "Standard" and "Poor" advice?  This would seem like going to the accounting firm of Dewey, Cheatham & Howe for tax advice.  Frankly, I want my investment ratings to come from a source that is Excellent and Rich.

 

I would like to see someone investigate the investments of those at S&P who made this rating call, because they knew full well that the downgrade would cause a quick panic across the markets, and I'm sure they have been busily covering their shorts this week.

Aug 11, 2011 5:31AM
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I'm not all that certain S&P is legitimate, The agency appears to have made some hefty financial mistakes of their own.  In a world of computers S&P might have a major glitch, or created one.

 

Perhaps S&P should be investigated, as well as their computer systems. The stock market has both its sharks and its bait.

 

As creditentailing goes, one man's opinion shouldn't be given so much stock. Again, if corporations continue playing monopoly as a means to increase their ways and means, they have reached a fork in the road.

Aug 11, 2011 5:45PM
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The fact is S&P was making big bucks to maintain AAA ratings on bad mortgage debt, so they did it. They are downgrading the US debt to try to attack the government (and other financial companies) for pursuing legal action against them over defrauding investors on mortgage debt.
Aug 10, 2011 4:45PM
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The S&P  trusted the judgment of the US in the US support of Fannie Mae and Freddie Mac.  That is why they did not downgrade Fannie and Freddie.  In issuing the downgrade, S & P is reducing the equality to reflect the fact that US debt issuances are destined to to be worth less as a result of monetizing the debt (paying debt with newly printed money and the anticipation of inflation.  The downgrade was appropriate.  So now S&P is criticized for re-assessing the lack of wisdom in US monetary and fiscal policy?
Aug 10, 2011 4:41PM
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The incident withthe banner was meant for Congress, not S & P.

You can't argue with facts, people, our government oversees an overextended and out of control spending government and S & P is only rating us on the facts...

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