One amusing aspect of the S&P downgrade fallout–at least for those familiar with the way all financial “ratings” work–is how normal this whole process has been.Anytime an analyst considers downgrade a beloved, sacred-cow rating, the following things happen:
- Everyone freaks out at the analyst’s company, knowing how much crap they’ll all get from the downgrade and how many relationships will be hurt and how much business might be lost
- There are a series of tense internal meetings to discuss the downgrade
- The analyst defends the downgrade and the analyst’s colleagues eventually become convinced or ask for more work to be done
- The analyst calls the “issuer” to discuss the logic behind the downgrade (without explicitly telling the issuer that the stock/bond will be downgraded–in part because the final decision hasn’t been made yet).
- The issuer figures out instantly what’s happening and completely freaks out.
- Management of the issuer try a range of desperate tactics to try to persuade the analyst not to downgrade.
- First incredulity (“Seriously? We’re shocked. We can’t imagine what you’re thinking.”)
- Then simple persuasion (“You’re obviously wrong–please give us an opportunity to show you why you’re wrong, so you don’t embarrass yourself.”)
- Then scientific logic (“Here’s why you’re wrong…”)
- Then threats (“Obviously you don’t understand our industry. Obviously you understand what this means about our relationship. Obviously we’ll defend ourselves.)
- Then begging and pleading for time (“Obviously this is a huge call that will shock and hurt a lot of people. What we’d recommend is that you take a few more days to evaluate this situation.”)
- And so on…
Then, if the analyst/firm decides to go ahead and downgrade, the fallout is usually quite similar to the fallout around the S&P downgrade:
- Everyone with an interest in preserving the old rating–issuers, investors, etc.–shreds the analyst/firm in every way possible: The analyst is an idiot. The analyst is carrying a grudge. The analyst is wrong. The analyst made a massive mistake. Etc.
- The issuer publishes a press release denouncing the analyst and explaining why he/she is wrong.
- The press plays up the denouncing, usually concluding that the analyst is an idiot.
- Everyone grumbles for a while
- Eventually, either the analyst is proven right and everyone else downgrades and the stock or bond craters…or the analyst is wrong and eventually falls on his/her sword and upgrades again
- Life goes on
This latter process–the impeachment of the analyst–is made much easier if the analyst has made a mathematical or other simple error in expressing his/her downgrade logic (as S&P just did, with its $2 trillion mistake). This gives the issuer something to harp on in all its outrage.
But the issuer harping on a “mistake” made by the analyst is almost always a sideshow. A key part of creating any “rating” on a security is evaluating the future, and the future cannot be evaluated precisely. And the truth is that there’s no precise difference between an AAA rating and an AA+ rating (or a “Buy” or “Hold”), at least not one that can be proven with an honest assessment of future scenarios.
So, ultimately, no matter who or what is involved, the rating process contains significant subjectivity. Ratings are opinions, not facts, and analysts are entitled to have opinions that are different than those held by “management.”
In other words, the S&P downgrade is playing out the same way pretty much any other big downgrade plays out, albeit at 100-times the scale.
S&P blew it big-time by making that boneheaded $2 trillion mistake. In so doing, they gave the Treasury something to seize on while ridiculing them, one that will persuade a lot of people that S&P is just incompetent (or politically motivated).
But the downgrade itself was perfectly justified, and the Treasury knows it.
In the past 10 years, the US has gone from a budget surplus to a $1.4 trillion deficit and piled up $14 trillion of debt, with deficits and borrowing continuing as far as the eye can see. Meanwhile, the US government has become paralysed by ideology: Only a week ago, a meaningful portion of the government was willing to put the US into default just because they weren’t getting EXACTLY what they wanted in the budget debate.
Those two facts alone are more than enough logic to support a downgrade. (And it’s also worth noting that they are the fault of the entire government, and prior governments, not just the current Administration.)
Treasury knows this. S&P knows this. And any sentient being who has been paying attention to the US’s fiscal situation in recent years knows it.
But that won’t derail the downgrade side-show, in which everyone seeks to deflect the blame.
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