S&P's Credibility Under Fire As Agency Issues US Debt Warning

April 19, 2011 -- Standard & Poor's sent shockwaves through Wall Street and Washington when it lowered its outlook on U.S. federal debt to "negative," but the credit-rating agency's own credibility has recently been called into question.

In fact, just last week a Senate investigations subcommittee ripped Standard & Poor's in a comprehensive report on the financial meltdown. The bipartisan report -- issued by Sen. Carl Levin, D-Mich., and Sen. Tom Coburn, R-Okla. -- in part blamed S&P for the crisis, saying the agency had inflated ratings on mortgage-backed securities for their own profit, only to later downgrade those ratings, destroying the value of the securities and contributing to the crisis.

"It was not in the short-term economic interest of either Moody's or S&P, however, to provide accurate credit ratings for high-risk RMBS and CDO securities, because doing so would have hurt their own revenues," Levin and Coburn said in their report. "Instead, the credit rating agencies' profits became increasingly reliant on the fees generated by issuing a large volume of structured finance ratings."

In short, the senators say, "Inaccurate AAA credit ratings introduced risk into the U.S. financial system and constituted a key cause of the financial crisis."

The credibility of S&P is especially significant in the wake of the rating agency's statement on Monday that it was starting to lose faith in the government's creditworthiness. While S&P maintained its best-possible AAA rating for US federal debt, the firm lowered its outlook from "stable" to "negative." The statement means the agency now thinks there is a one-in-three chance that it will reduce the rating of the bonds in the next few years.

The S&P report quickly reverberated from Wall Street to Washington. On Monday major market indicators recorded their biggest one-day drop in more than a month. In Washington -- where a debate is raging on whether to raise the country's debt ceiling -- lawmakers pounced on the report for partisan gains.

House Majority Leader Eric Cantor, R-Va., said the report should serve as a "wake-up call" to Democrats who want to increase the country's $14.3 trillion debt ceiling. Republicans, Cantor warned, will only vote to raise the limit if the deal includes "meaningful fiscal reforms."

"Serious reforms are needed to ensure America's fiscal health, and today S&P sent a wake-up call to those in Washington asking Congress to blindly increase the debt limit," Cantor said. "Today's announcement makes clear that the debt limit increase proposed by the Obama administration must be accompanied by meaningful fiscal reforms that immediately reduce federal spending and stop our nation from digging itself further into debt."

Coburn argued that the S&P report "highlights the dangers of waiting for the perfect political moment to tackle our debt crisis."

"Waiting until the next election puts our fiscal and national security at risk," Coburn said. "It's time for both sides to drop their partisan talking points and decide what we can do together while we still control our own destiny. If we refuse to negotiate within our own government, we will soon find ourselves negotiating with foreign governments and the international financial community on terms far less favorable than we enjoy today."

The inability of Congress to rein in the nation's soaring deficits in recent years was at the heart of S&P's concerns. However, the agency did applaud new efforts from both sides of the aisle to tackle the country's long-term fiscal problems. Earlier this month Rep. Paul Ryan, the head of the House Budget Committee, unveiled the Republicans' budget proposal that would slash $4.4 trillion in red ink over the next decade. Just last week President Obama countered with his own plan that would cut $4 trillion in the next 12 years.

"We view President Obama's and Congressman Ryan's proposals as the starting point of a process aimed at broader engagement, which could result in substantial and lasting U.S. government fiscal consolidation," S&P noted. "That said, we see the path to agreement as challenging because the gap between the parties remains wide. We believe there is a significant risk that Congressional negotiations could result in no agreement on a medium-term fiscal strategy until after the fall 2012 Congressional and Presidential elections."

The Treasury Department countered by accusing S&P of underestimating the likelihood that lawmakers would reach an agreement before then.

"S&P assumes that the U.S. will enact 'a comprehensive budgetary consolidation program – combined with meaningful steps toward implementation by 2013,' but we believe S&P's negative outlook underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation," said Mary Miller, Treasury's assistant secretary for financial markets.

Levin is currently traveling overseas and was unavailable to comment for this story.