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Washington Notebook: Blindsided - The S&P Downgrade

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Although the key players in this Administration may NOT have been shocked by the S&P downgrade late last Friday night just after the markets closed - the rest of us clearly were blindsided!

It was the first time in history the American economy was wounded and held hostage by the actions of one single company -
Standard & Poors.

What was perhaps most puzzling about this whole thing was the political element of the
S&P rationale.

Despite the fact that Congress had actually reached an agreement that was designed to cut the amount of debt the rating agencies requested from the budget, S&P nevertheless chose to take this unprecedented action.

Last I heard America was a representative democracy - the Founders long ago established a system of government that is designed to achieve balance and compromise between competing interests - no matter how in-artful or painful it might be to watch.

No one disputes that observing the political rhetoric and partisan theatrics of the Debt Deal was not a pretty sight.

However, it did in the end achieve a deal designed to begin the process back toward balance.

Instead of lauding this first difficult step toward deficit reduction, this one rating agency decided to give Congress a black-eye and in so doing may have inflicted serious damage on the U.S. and Global economies.

One is forced to wonder exactly how S&P made this political assessment. Did their analysts actually speak with the Leaders in Congress or was their decision to condemn the dysfunctional U.S. legislative process solely based on 24-hour media coverage?

Perhaps they are unaware that the presidential and congressional election cycle is already well underway.

Political grandstanding, boisterous bombasity and outrageous rhetoric are part of the political dance - to arouse the partisan base.

These political antics are not aimed at an audience like the global financial community and therefore should not be given such serious weight.

As far as I know S&P does not possess a crystal ball so they would have no way of knowing just how 'Phase II' of the Congressional deal will actually work out.

They did not know who would actually be chosen for the "Super Committee" - now officially called the Joint Select Committee on Deficit Reduction - or what decisions that group of senators would recommend.

Even if their pessimism is well founded, Congress has put in place a mechanism to force more automatic across-the-board cuts which will hang like the sword of Damocles over this Committee.

These cuts should force them to actually make the tough choices or suffer unpalatable cuts to their favourite appropriations which will be forced down their collective throats.

I find it hard to believe that S&P thinks it can predict with certainty the results of the next election cycle when professionals who have devoted their life's work to this task would never dare to be so brazen.

As we enter a second week of grave fiscal uncertainty the American people should be asking themselves the question - How did we allowed one rating agency to have this much power and influence?

This is worse than - "Too Big To Fail".

Perhaps, as some of the financial experts I have been speaking with reminded me - We should have asked that question and dealt with the answer some time in 2008 when S&P along with the other rating agencies clearly missed the boat - maintaining the triple AAA ratings of the securitised mortgages that became the toxic assets responsible for starting this mess in the first place.

Although these are somewhat sophisticated financial products - which S&P claimed to understand - they clearly did not or they would have downgraded them long before the avalanche took place in 2008.

Comparing these financial products, these toxic assets, to the complexity of the U.S. Economy is like comparing kite flying to the Space Shuttle.

The U.S. Economy and budget process is so complex and multifaceted that it defies predictability or accurate analysis.

Just ask the professionals at the Congress Budget Office who have been scoring these proposals for years.

There is no question that both the deficit and the debt are indeed 'supersized' - but there is also no question that the power of the U.S. economy is vast, resilient and powerful.

If normal growth were to return - that growth would significantly eat away at the red ink.

A small shift in business and consumer confidence could have dramatic results as well - there are many delicate intangibles that have the ability to move this huge economic engine.

Even more important than one policy or another is giving business and consumers long term certainty of what will happen in the next few years.

The Federal Reserve on Tuesday tried to do just that by committing not raise interest rates until 2013 and hinting that they will use their other tools, if necessary, to stabilize the economy.

It is also clear that there is no one easy answer to make this happen overnight - this problem grew over a ten year period. As a result it will take some time to correct.

It should be noted that severe and immediate austerity has its own costs in social unrest.

You need look no further than the protests in the streets in Greece or the rioting and looting throughout the UK.

You simply cannot severely cut programs to the less fortunate - all at once - without risking social upheaval.

In fact, the deficit and debt did not even become a hot button political issue until one of the party's found it politically expedient.

If S&P's judgment is reliable we need to ask why they did not downgrade the U.S. in 2008 when the economy was on the verge of falling off the cliff?

Why didn't they downgrade the U.S. in 2000 when the U.S. was unable to quickly settle its presidential election? - Talk about "political instability".

Where were S&P when the U.S. announced it was entering not one but two wars - without any means to pay for them.

The answer to these questions, some say, is they were doing their job properly - which was not to make political assessments of these actions but to assess the ability and likelihood of the U.S. to pay its debts.

If their concern is based on political instability why have S&P not downgraded other nations?

Why did S&P and the other rating agencies fail to warn us of the impending European Debt Crisis long ago?

Clearly the political environment cannot be ignored however, I would argue that this kind of political analysis is not S&P's area of expertise.

The real question here is can and will the U.S. pay its debts? And the undeniable answer is a resounding YES.

S&P's announcement of the U.S. downgrade and the downgrade of Fannie Mae and Freddie Mac have probably done more damage to public and business confidence than is reasonably justified - they have hurt the value of 401 K plans and home values once again - just as things were slowly beginning to recover from their last hit - when S&P and the other rating agencies failed to send a warning in 2008.

It seems more than a coincidence that all of this is happening at the same time the regulators are working on the new rules for many of the financial market players - including the rating agencies - to prevent another 2008 style meltdown.

Although most people who are not part of the business world do not know that S&P typically is hired and charges a fee for their ratings service.

They have decided to offer their opinion on U.S. debt - whether it is welcome or not.

Perhaps it is time to re-examine rating agencies for both the role they play and the power they wield in the market place.

This is of course unless the damage they have inflicted actually takes hold and the world community allows and accepts such unfounded pronouncements to push us back into global recession.

With Tuesday's market rebound and Wednesday's numbers still to come, it appears at least for the moment, that investors may be discounting the S&P downgrade and fighting back.

This blog can also be read on Sky News