S&P's U.S. Downgrade Is a Sham and a Shame

Includes: IEF, IYF, SHY, TLT
by: The Other Street
At first read, Congress and the Administration are the ones to blame for this downgrade. There is no doubt about it. However, here is where the S&P explanation becomes questionable. From the 3rd paragraph of its release dated August 5 at 20:13 EST:

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any

time soon.

Get a grip. This is the same agency that was in bed with the Banks, and Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) which, last I looked, were Government Sponsored Enterprises at the time of the subprime and CDO hoax. They are now wondering about the “effectiveness” of Washington? They are “pessimistic” about the gulf between parties? Where have they been for the past four years? Indeed, for as long as I can remember.
It becomes worse:

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers.

Let's take a few numbers, Gross Government Debt, Public Debt, and External Debt. As a percent of GDP, here is the list for six selected countries. Click to enlarge:
Click to enlarge
The credit rating of Japan is AA minus, and that of the UK, France and Germany is AAA. Take a closer look at the number on top, Public Debt. The difference with Gross Debt is that it excludes intergovernmental agency borrowings. One can argue Gross Debt is what counts, but there is a debate out there. If entitlements are cut or Social Security taxes increased, a lot of that difference goes away. If I take Public Debt, we are in a way better shape than the others. Now take the last number, External Debt. This is the total public and private debt owed to non-residents. It looks to me as if the UK, France and Germany, when taken as countries as a whole, owe a lot more than the US. Ireland holds the medal, with 1108% of GDP owed to foreigners - including the UK... And as far as Japan goes, sure their numbers are dire. Then how come the yen is rivaling the Swissie as a safe haven...?
So, contrary to their pretense, neither S&P’s perfect knowledge of how Washington works nor its methodology justify this downgrade. What happened is simple, and two-fold. First, S&P put itself in a box by using the original $4 trillion number that Joe Biden and President Obama floated, knowing full well it was not achievable without tax increases, the main deal point. At the risk of losing credibility, it could not back track. Besides, let’s assume taxes had been raised – which they will be, actually, as the current laws expire. How would S&P regard a fiscal contraction in the middle of a doubtful recovery?
Second, following their total failure that led to the current financial crisis, they are trying to put lipstick on their face. They were the main culprits then, and they did not care about Main Street, or Wall Street for that matter. Without their complicity, the toxic paper would have been issued as junk, not AAA, or not at all. Offense being the best defense, S&P is now looking for a new virginity. In so doing, they are again hurting Main Street, and Wall Street. They did not care then, they do not care now. They were not explaining their ratings then, they are using phony reasons now. Courageously too:

Standard & Poor's takes no position on the mix of spending and revenue

measures that Congress and the Administration might conclude is appropriate

for putting the U.S.'s finances on a sustainable footing.

In other words, just do it. You know, like the English, the French, and the Germans. We trust them. Hum, not sure about you guys.
This really gets me going. I want to remind S&P of two main things. One, our government is way more transparent than Europe’s. What you see on CSpan you don’t see over there. Whether you like Fox News or not, you don’t have a choice in France – can’t get it. When it comes to the financial system, it is totally inbred between adminsistrations, banks, insurance companies and industrial concerns. Leaders do not come from a variety of Universities – there is one or two by country. It is a cast system. Indeed, a system that created the United States, with people fleeing Europe.
Two. This is the backdrop, what counts is “effectiveness, stability, and predictability”, to use S&P’s own rhetoric. One thing for sure, we are in the second phase of a large scale financial crisis. It was private debt then, it is sovereign debt now. In both cases, the nominal debt is the tip of the CDO/CDS iceberg. What have we done in the US? Something big. Paulson’s bazooka and QE. $1.7 trillion. It stopped the bleeding, but the patient still has not recovered. What has Europe done? A little of this, a little of that. The truth is, they rode our coattails, with their banks fully benefiting from our programs. I refer here to fellow SA contributor John Mason, and to his article of June 28 . By his count, foreign banks' deposits at the Fed rose by $500 billion in a year, i.e. some 80% of QE2.
Now, this was Two. How about 2.2? Sure, we debate here about how to go about the problem. We have the Debt ceiling. Europe does not and has no clue. We have the Fed and the Treasury. They have the ECB, a feeble cousin, but they have the more flamboyant European Financial Stability Fund (EFSF). Simply put, a sick joke. This is a Luxembourg-based company which can issue up to euro 700 billion that it will lend to any of the 17 Member States that are Members to the agreement, and who will guarantee the loans. Are you kidding me?? Among the 17 Members: Ireland, Spain, Italy, Portugal, Greece, Belgium. They will guarantee the loans to themselves? It’s a Ponzi – and S&P trusts this? As Charles Dickens said,

Credit is a system whereby a person who cannot pay gets another person who cannot pay to guarantee that he can pay.

It gets even worse. On July 11, the European Stability Mechanism (ESM) Treaty was signed, to extend the life of the EFSF. EFSF was to issue bonds, backed by Member States guarantees, more than questionable. The ESM has real capital, not just guarantees. Here is the next sick joke. The ratio between paid-in capital and the outstanding amount of ESM issuances would be 15%. As of now, paid-in capital is euro 80 billion, with callable capital of euro 620 billion. See here.
S&P, chastise Congress and the Administration. But this is a relative game – you are easy on the other culprits, including Canada where you publish from. You make personality judgments which are short term emotional and borderline biased. You are not a daily blog, you are supposed to be a reference. Even with a lot of lipstick on your face, you can’t fly.
This S&P downgrade is both a sham and a shame. Live by the sword, die by the sword. Your rating business is now officially over.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.