The e-mail message that unleashed hours of debate between U.S. Treasury Department officials and Standard & Poor’s arrived at 1:45 p.m. on Aug. 5, just as U.S. and European stock markets were limping toward the end of their worst week since 2008.
Something didn’t look right to John Bellows, the Treasury’s acting assistant secretary for economic policy. He found what he later called a $2 trillion “basic math error” in the e-mail, a preliminary press release announcing S&P’s first-ever downgrade of U.S. creditworthiness.
Over the next 5 1/2 hours, the two sides argued over issues ranging from so-called baseline calculations to deficits, according to a person familiar with the matter. In the end, the ratings firm stuck with its decision, citing the level of government debt and the contentious political climate in Washington.
The debate in Congress over raising the debt limit “highlighted a degree of uncertainty around the political policymaking process which we think is incompatible with a AAA rating,” David Beers, S&P’s managing director of sovereign ratings, said later on a conference call with reporters.
That judgment raised “fundamental questions about the credibility and integrity of S&P’s ratings action,” Bellows wrote in a Treasury blog post yesterday. “Independent of this error, there is no justifiable rationale for downgrading the debt of the United States.”
The dispute stems from how New York-based S&P, a unit of The McGraw-Hill Companies, Inc., used figures from the Congressional Budget Office. The discrepancy didn’t change the downgrade decision, S&P said, because Treasury’s $2 trillion figure was derived by calculating government debt over a 10-year period while S&P’s ratings are determined using a three- to five-year time horizon.
The day of S&P’s decision started with financial markets fluctuating on concerns about Europe’s ability to manage its debt crisis. That morning, the firm’s credit committee approved the downgrade.
After Bellows and other Treasury officials discussed what they viewed as serious flaws in S&P’s analysis, they notified the ratings firm around 3:15 p.m., said the person, who declined to be identified because the discussions weren’t public.
Meanwhile, an early rally in U.S. stocks faded on speculation that an S&P downgrade of the U.S. was imminent. The Standard & Poor’s 500 Index ended 0.1 percent lower at 1,199.38 after rising as much as 1.5 percent. For the week, the index slumped 7.2 percent, the biggest drop since November 2008.
S&P called back about 5:30 p.m. to acknowledge the discrepancy and changed the debt-to-gross domestic product numbers in the report, the person said. S&P told the Treasury that a majority of the credit committee had been made aware of the matter and had not changed their decision.
At 6:20 p.m., Mary Miller, the Treasury’s assistant secretary for financial markets, left a voicemail with an S&P executive and said the firm’s analysis was inconsistent with one of the charts in the report, the person said.
S&P reiterated to the Treasury around 7:15 p.m. that it planned to move ahead with the downgrade and sent Treasury officials the final press release around 8 p.m. It was sent to news outlets about 15 minutes later.
Just before 9 p.m., a Treasury spokesman told reporters S&P had made a $2 trillion error.
The firm’s reply came a few minutes after midnight with an e-mailed statement saying the rating was unaffected by the “change of assumptions.”
“The primary focus remained on the current level of debt, the trajectory of debt as a share of the economy, and the lack of apparent willingness of elected officials as a group to deal with the U.S. medium-term fiscal outlook,” S&P said. “None of these key factors was meaningfully affected by the assumption revisions to the assumed growth of discretionary outlays and thus had no impact on the rating decision.”
On a conference call yesterday with reporters, John Chambers, chairman of S&P’s sovereign ratings committee, and Beers said that in their analysis, the “extremely difficult” political discussions in Washington over how to reduce the more than $1 trillion budget deficit carried more weight in their decision than the nation’s outstanding debt.
The S&P decision went further than Moody’s Investors Service and Fitch Ratings, which affirmed their AAA credit ratings for the U.S. on Aug. 2, the day President Barack Obama signed a bill that ended the debt-ceiling impasse that pushed the country to the edge of default. Moody’s and Fitch both said that downgrades were possible if lawmakers failed to enact debt reduction measures and the economy weakened.
In his blog posting yesterday, Bellows said the error occurred because S&P took CBO numbers and applied them to the wrong starting point, or baseline.
“The impact of this mistake was to dramatically overstate projected deficits -- by $2 trillion over 10 years,” he said.
Chambers told CNN television Aug. 5 that S&P accepted the Treasury’s view on the baseline “and our figures that we have published reflect that.”
“The important thing to say in this is that the amounts that we’re talking about, say up to about 2015, you’re talking about 1.5 percent of GDP of difference in your debt,” Chambers said. “It doesn’t make a material difference” because it doesn’t change the fact that the U.S. debt-to-gross domestic product ratio will probably continue to rise in the next decade, he said.
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