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S&P Analysis Was Flawed by $2 Trillion Error, Treasury Says

Aug. 6 (Bloomberg) -- Standard & Poor’s decision to downgrade the U.S. credit rating was flawed by a $2 trillion error, according to a Treasury Department spokesman.

S&P lowered the nation’s AAA grade one level to AA+ yesterday, after warning on July 14 that it would reduce the ranking in the absence of a “credible” plan to lower deficits even if the nation’s $14.3 trillion debt limit were lifted. The outlook was kept as “negative.”

The Treasury disagreed with S&P’s assessment because the analysis was carried out hastily, said a person familiar with the matter who declined to be identified because the discussions were private. The ratings firm erred in estimating discretionary spending levels at $2 trillion higher than Congressional Budget Office estimates, the person said.

S&P, in a statement, disputed the Treasury’s assertions and said using the department’s approach to the CBO figures didn’t affect the ratings decision. The Treasury’s $2 trillion figure was derived by calculating government debt over a 10-year period, S&P said.

“Our ratings are determined primarily using a 3-5 year time horizon,” S&P said in the statement. When projecting government debt through 2015, the discrepancy between the Treasury’s approach and S&P’s approach to the CBO figures amounts to $345 billion, the ratings firm said.

“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,” the firm 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.”

Moody’s, Fitch

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 fail to enact debt reduction measures and the economy weakens.

Steven Hess, a senior credit officer at Moody’s in New York, said at the time that while the compromise between Obama and members of Congress was “a positive step” toward reducing the deficit, “we do think more needs to be done.”

S&P, in its earlier statement explaining the downgrade, said that the deficit-cutting plan signed by Obama after months of wrangling with Congress falls short of what “would be necessary to stabilize the government’s medium-term debt dynamics.”

U.S. Politics

After being alerted to that, S&P lowered its calculations by $2 trillion and then relied largely on judgments about U.S. politics to support the downgrade, the person said. The Treasury was presented with the S&P analysis shortly before 2 p.m. yesterday.

S&P said in its statement that it may lower the long-term rating to AA within the next two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt.

The wrangling over raising the nation’s debt ceiling indicates that “further near term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process,” S&P said.

S&P currently gives 18 sovereign entities its top ranking, including Australia, Hong Kong and the Isle of Man, according to a July report. The U.K. which is estimated to have debt-to-GDP this year of 80 percent, 6 percentage points higher than the U.S., also has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P said in yesterday’s statement.

New Zealand is the only country other than the U.S. that has a AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.

To contact the reporter on this story: Ian Katz in Washington at ikatz2@bloomberg.net; Vincent Del Giudice in Washington at vdelgiudice@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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