The U.S. lost its top credit grade in August because of the imminent danger of a “real liquidity crisis,” and Standard & Poor’s made no errors in its analysis, said Moritz Kraemer, managing director of sovereign ratings.
“Last summer, the U.S. government got extremely close to a real liquidity crisis because the Washington establishment could not agree on the way forward that would have been required to raise the debt ceiling,” Kraemer told lawmakers on the U.K. Parliament’s Treasury Committee today in London.
S&P cut the rating by one level to AA+ on Aug. 5, criticizing the nation’s political process and saying that spending cuts agreed on by lawmakers wouldn’t be enough to reduce record deficits. Treasuries surged after the move, and while Moody’s Investors Service and Fitch Ratings have kept their top grades on the U.S., both have a negative outlook. The U.S. Treasury criticized S&P for flawed analysis.
“There was no mistake,” Kraemer said. “There were different scenarios. These are measures about the future which you have to have an analytical debate on what is the likely strategy of fiscal consolidation the government might take.”
S&P made a $2 trillion error and then changed the rationale for its decision, raising “fundamental questions about the credibility and integrity” of its ratings action, John Bellows, acting assistant secretary for economic policy, wrote in a Treasury blog post on Aug. 6.
Kraemer dismissed that analysis, echoing comments at the time by David Beers, S&P’s former head of sovereign ratings, who said it was a “complete misrepresentation” of what happened. Kraemer’s testimony today was part of an inquiry by lawmakers into credit rating companies.
Treasuries have returned 4.5 percent since S&P cut the U.S. and gained 9.8 percent last year, their best performance since 2008, according to Bank of America Merrill Lynch index data. Yields on U.S. government bonds due in 10 years touched 1.67 percent on Sept. 23, the lowest ever.
The discussion with the Treasury before the downgrade was announced “was about which of the scenarios which were published by the Congressional Budget Office, which is a nonpartisan institution, should be underlying the analysis,” Kraemer said. “Originally the S&P team was following the alternative scenario of the CBO, the alternative fiscal scenario, which in terms of expenditure trajectory did foresee a growth in spending in line broadly with nominal GDP.”
S&P agreed to use a different scenario after a “normal process of interaction” with Treasury officials, Kraemer said.
“The 2 trillion is the difference in the net debt ratio in 2021 depending on which scenario you use,” he said. “Under the alternative scenario, which we had initially pursued, the debt ratio in 2021 would have come up at $22 trillion -- I’m using round numbers -- 22.1, which is 2 trillion higher than under the baseline scenario, which is 20 trillion.”
In August S&P said it went ahead with a downgrade because the 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.
Questioned today on why Finland is graded AAA while the U.S. has lost its top rating, Kraemer highlighted the differences in both nations’ political environment.
“The debt ratio in the U.S. is much higher, the debt trajectory is more adverse, but most importantly, it has been our finding at least, people may come to different conclusions on that, but we felt the governance challenges that the U.S. political system is facing in generating a coherent strategy of getting the public finance challenge under control are more pronounced than they are in Finland,” Kraemer said.