Bloomberg News

Treasury Disputes S&P Math, Saying Downgrade Doesn’t Add Up

August 07, 2011

(Adds data on Treasuries in fifth paragraph. For more on S&P’s downgrade of the U.S. credit rating, see {EXT3 <GO>}.)

Aug. 7 (Bloomberg) -- The U.S. Treasury Department said there is “no justifiable rationale” for Standard & Poor’s move to downgrade the nation’s credit rating as global finance ministry officials prepared responses to the historic announcement.

Standard & Poor’s officials stood by their decision announced Aug. 5 and laid blame on a political system that failed to adequately address deficit reduction in the compromise law that President Barack Obama signed Aug. 2 to avert a U.S. default on its debt.

The Treasury Department issued a statement saying S&P had acknowledged an “error” in its calculations and that the rating company made a $2 trillion mistake.

Euro-region central bank governors will hold emergency talks today aimed at limiting the market fallout from the U.S. downgrade and stopping Spain and Italy from becoming the next victims of the sovereign-debt crisis. The central bank heads will hold a conference call at 6 p.m. Paris time, said a central bank official, who declined to be identified because the talks are confidential.

Investors seeking a haven amid concerns the global economic rebound is fading have bought Treasuries in recent weeks, even after S&P warned it may lower the U.S. rating. Yields on benchmark 10-year notes closed at 2.56 percent Aug. 5, before S&P announced its decision, down from 3.12 percent a month ago.

Reassuring Investors

The Obama administration worked yesterday to reassure investors around the world that Treasury securities remain a safe place to invest and sought to limit any negative effects on the economy, in part by criticizing S&P, according to an administration official who spoke on the condition of anonymity.

Meanwhile, some lawmakers said yesterday the S&P downgrade announcement may put pressure on Congress to come up with more significant deficit reduction in the coming months. Senator Tom Coburn, an Oklahoma Republican and a member of the so-called Gang of Six that has been working since early this year on a bipartisan deficit-reduction plan, said the S&P downgrade was “probably long overdue.”

“For decades, political careerism has trumped statesmanship in Washington,” Coburn said in a statement yesterday. “Both parties have done what is safe, not what is right. The dysfunction in Washington is the belief that we can live beyond our means forever. We can’t.”

Partisan Gamesmanship

Senate Majority Whip Richard Durbin, an Illinois Democrat, said the downgrade underscores the need for a “comprehensive solution to the problem” that includes more federal revenue.

The downgrade “is also a political one,” he said in an e- mail yesterday. “Partisan gamesmanship has left global markets, rating agencies and the American people searching for stability.”

Former Senator Alan Simpson, a Wyoming Republican who served as co-chairman of President Barack Obama’s fiscal commission, said he hopes the S&P downgrade will cause lawmakers to take deficit deliberations more seriously.

“It ought to push them more toward reality and the reality is if you spend a buck and borrow 41 cents, you have to be very stupid,” Simpson said in a phone interview yesterday.

Obama was spending the weekend at the Camp David presidential retreat in the Maryland mountains. There were no plans for him to make a statement reacting to the S&P downgrade, according to an administration official, who wasn’t authorized to speak publicly.

Methodology Objection

The president will urge Congress in coming weeks to set aside “our political and ideological differences” and work for deficit reduction and economic recovery, White House Press Secretary Jay Carney said in an e-mailed statement yesterday. The four-paragraph statement didn’t mention the S&P downgrade.

A person familiar with the discussions between the Treasury Department and S&P said Treasury officials objected to the methodology the agency used in issuing the downgrade. The person said the differing verdicts from the agencies may limit the effects of the S&P move. Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings Aug. 2, the day Obama signed the bill that ended the debt-ceiling impasse.

The deal includes $917 billion in spending cuts over the next decade and calls for a joint committee, comprised of six Republican lawmakers and six Democrats, to find as much as $1.5 trillion more by Nov. 23. If the panel is unable to agree on a plan or if its recommendations are rejected by Congress before year’s end, there would be automatic $1.2 trillion in across- the-board reductions starting in January 2013.

Asian Retention

Asian investors are likely to retain their Treasury holdings for now, with alternatives limited by the region’s foreign- exchange rate policies. Japan, the second-largest international investor in U.S. government debt, sees no problem with trust in the securities, a Japanese government official said on the condition of anonymity yesterday.

New York-based S&P lowered the AAA credit rating for the U.S. by one level, to AA+, in response to the deal Obama and lawmakers reached to raise the $14.3 trillion debt limit.

The company’s statement on the downgrade said it’s “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 anytime soon.”

‘Wake-Up Call’

Donald Marron, director of the Tax Policy Center, a nonpartisan research group in Washington, said the downgrade is “another wake-up call” for Obama and lawmakers to address deficit issues, though he said “it’s not obvious to me that we have compromise bursting out all over the next six months.”

Alice Rivlin, former President Bill Clinton’s budget director who served on a fiscal commission Obama set up last year, said “the downgrade provides no new information.”

“One possible positive” of S&P’s move could be that it prods the committee “into coming up with a big deficit- reduction package -- bigger than the $1.2 trillion called for in the ‘trigger’,” said Ajay Rajadhyaksha, head of U.S. fixed- income strategy at Barclays Capital in New York.

S&P noted in its report that the failure to act on increasing government revenue also was a consideration in its decision. The rating company said it no longer assumes that the 2001 and 2003 tax cuts enacted under President George W. Bush would expire by the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”

Tax Revenue

Senator Orrin Hatch of Utah, the top Republican on the tax-writing Senate Finance Committee, in a statement yesterday said raising taxes in a weak economy “would be an extremely wrong-headed approach.”

S&P currently gives 18 sovereign entities its top ranking. The U.K., with a debt estimated at 80 percent of GDP this year, or 6 percentage points higher than the U.S., has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P has said.

New Zealand is the only country other than the U.S. that has an AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.

The rating cut puts the U.S. in an expanding club of Western nations from Greece to Spain whose deteriorating credit quality has provoked downgrades in the past year. Italy also faces such a threat, according to a statement from S&P in July.

--With assistance from Kathleen Hunter, Margaret Talev, Roger Runningen, Heidi Przybyla, Julianna Goldman and Brian Faler in Washington. Editors: Christopher Scinta, Digby Lidstone

To contact the reporter on this story: Ian Katz in Washington at Ikatz2@bloomberg.net; Steven Sloan in Washington at Ssloan7@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net.


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