S&P’s credibility

Sta. Ana coordinates Action for Economic Reforms. This piece was published in the August 8, 2011 edition of the BusinessWorld, pages S1/4 to S1/5.

 

One might believe that the Standard and Poor’s (S&P) downgrade of the US credit rating is most instrumental in influencing the behavior of global markets.  Stock markets in major financial centers took a precipitous fall, the worst since the crisis that erupted in 2008.

The Philippine stock market likewise fell. And the peso depreciated by PhP0.32, which may have the consolation of alleviating the worry of the tradable sectors that the exchange rate is becoming increasingly uncompetitive.

But if markets still believe that credit rating agencies like S&P have powerful insights to shape economic and business decisions, then woe to us all.  Our markets deserve to be punished, if we merely follow what the credit raters say.

Perhaps, S&P and the markets simultaneously think the same way. They have the perception that the US deficit is intractable and that US political leaders lack the ability to address the problem. This has gravely undermined their confidence in the US economy.

Yet, other credit rating agencies, Moody’s and Fitch, were cautious, preferring to maintain their triple-A rating for the US.

I thought markets and other institutions had already burst the myth that credit rating agencies offer sound information and solid analysis. For they have been wrong in many instances.

Recall that the credit rating agencies were so bullish about the Philippine economy during the term of the overrated Fidel Ramos administration.  Yet the economy stumbled, in conjunction with the Asian financial crisis in 1997, arising from the steep overvaluation of the peso. Neither did the credit rating agencies anticipate the Asian crisis and other regional crises that had worldwide impact.  And even much earlier, in 1987, they were caught unaware by the US equity crash.

The credit rating agencies did not learn their lessons, and they remained prophets of boom on the eve of the US economic meltdown in 2008, triggered by the subprime mortgage.  They even certified the mortgaged-back securities as safe investments.

The fact is,the most brilliant economist or technician is constrained by information problems, what the literature calls information asymmetry, in assessing systemic risks.

Worse, the credit rating agencies suffer from perverse incentives.  They earn their profits and upkeep from the services they provide to bankers and investors.

That said, is S&P correct in its decision to downgrade the US credit rating?The Associated Press quotedDavid Beers, S&P’s head for sovereign ratings regarding the reason for the downgrade. It was the concern over “the degree of uncertainty around the political policy process. The nature of the debate and the difficulty in framing a political consensus…that was the key consideration.”

In short, S&P has judged US institutions a failure.  But one can argue that a political consensus, no matter how deeply flawed, was forged.  What S&P wanted was a bigger cut in the budget, amounting to US$ four trillion over ten years, very far from the consensus of a cut between US$2.1 and US$2.4 trillion for the same period.

Yet, the future is always uncertain and the sharp cuts that S&P are demanding could only make things worse. We cannot preclude the possibility of the US economy falling into a trap of a long period of stagnation, similar to Japan’s lost decade in the 1990s.

In breaking the impasse on the debt ceiling, the BarackObama administration had a limited choice: between the devil and the deep blue sea. Obama chose to surrender to the Republicans, thus preventing a temporary government shutdown.

President Obama has become quite predictable in his strategy—always trying to accommodate the other side.  We have seen this on his compromises in health reforms, in financial regulation, and in the fiscal stimulus. This is a bad strategy when dealing with bad guys.  Being cooperative works only when one can demonstrate that you are capable of retaliating and striking hard.

But the costs will turn out to be much more damaging.  S&P and the markets remained unconvinced and dissatisfied.  Perhaps, the US deserves a downgrade, but that doesn’t necessarily make S&P’s analysis sound.

Even before the debt ceiling deal was struck, Paul Krugman wrote:  “It will damage an already depressed economy; it will probably make America’s long-run deficit problem worse, not better; and most important, by demonstrating that raw extortion works and carries no political cost, it will take America a long way down the road to banana-republic status.”

Now whom will you side with? Krugman, a Nobel prize winner and whose analysis on the US recession has reflected reality? Or S&P, with a proven track record of failure in assessing risks?

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