Treasury Department Points out Out $2 Trillion Error in S&P's
report
After Standard and Poor's informed the government of its
intention to downgrade the national rating from a pristine AAA to AA+,
Treasury officials in Washington huddled to look over the ratings agency’s
draft press release. It was reportedly John Bellows who noticed within
minutes that S&P had made a glaring error that placed its calculations about
the U.S. deficit off by about $2.1 trillion.
Treasury Secretary Tim Geithner quickly pushed back at S&P, pointing to the
error. The agency acknowledged its mistake, then said it was charging ahead
with the ratings change anyway. Later that evening, it officially downgraded
American debt.
--------------------------------------------
Just the Facts: S&P's $2 Trillion Mistake By: John Bellows - Acting
Assistant Secretary for Economic Policy
8/6/2011 In a document provided to Treasury on Friday afternoon, Standard
and Poor’s (S&P) presented a judgment about the credit rating of the U.S.
that was based on a $2 trillion mistake. After Treasury pointed out this
error – a basic math error of significant consequence – S&P still chose to
proceed with their flawed judgment by simply changing their principal
rationale for their credit rating decision from an economic one to a
political one.
S&P has said their decision to downgrade the U.S. was based in part on the
fact that the Budget Control Act, which will reduce projected deficits by
more than $2 trillion over the next 10 years, fell short of their $4
trillion expectation for deficit reduction. Clearly, in that context, S&P
considers a $2 trillion change to projected deficits to be very significant.
Yet, although S&P's math error understated the deficit reduction in the
Budget Control Act by $2 trillion, they found this same sum insignificant in
this instance.
In fact, S&P’s $2 trillion mistake led to a very misleading picture of debt
sustainability – the foundation for their initial judgment. This mistake
undermined the economic justification for S&P’s credit rating decision. Yet
after acknowledging their mistake, S&P simply removed a prominent discussion
of the economic justification from their document.
In their initial, incorrect estimates, S&P projected that the debt as a
share of GDP would rise rapidly through the middle of the decade, and they
cited this as a primary reason for a downgrade.
In S&P’s corrected estimates – which lowered S&P's projection of future
deficits by $2 trillion over 10 years and lowered S&P's estimate of debt as
a share of GDP in 2021 by 8 percentage points - public debt is much more
stable.
The error came about because S&P took the amount of deficit reduction CBO
calculated from the Budget Control Act and applied it to the wrong starting
point, or “baseline.”
Specifically, CBO calculated that the Budget Control Act, including its
discretionary caps, would save $2.1 trillion relative to a “baseline” in
which current discretionary funding levels grow with inflation.
S&P incorrectly added that same $2.1 trillion in deficit reduction to an
entirely different “baseline” where discretionary funding levels grow with
nominal GDP over the next 10 years. Relative to this alternative “baseline,”
the Budget Control Act will save more than $4 trillion over ten years – or
over $2 trillion more than S&P calculated. (The baseline in which
discretionary spending grows with nominal GDP is substantially higher
because CBO assumes that nominal GDP grows by just under 5 percent a year on
average, while inflation is around 2.5 percent a year on average.
The impact of this mistake was to dramatically overstate projected
deficits—by $2 trillion over 10 years. As anybody who has followed the
fiscal discussions knows, a change of this magnitude is very significant.
Nonetheless, S&P did not believe a mistake of this magnitude was significant
enough to warrant reconsidering their judgment, or even significant enough
to warrant another day to carefully re-evaluate their analysis.
S&P acknowledged this error – in private conversations with Treasury on
Friday afternoon and then publicly early Saturday morning. In the interim,
they chose to issue a downgrade of the US credit rating.
Independent of this error, there is no justifiable rationale for downgrading
the debt of the United States. There are millions of investors around the
globe that trade Treasury securities. They assess our creditworthiness every
minute of every day, and their collective judgment is that the U.S. has the
means and political will to make good on its obligations. The magnitude of
this mistake – and the haste with which S&P changed its principal rationale
for action when presented with this error – raise fundamental questions
about the credibility and integrity of S&P’s ratings action.
John Bellows is Acting Assistant Secretary for Economic Policy
http://www.businessinsider.com/downgrade-treasury-spells-out-sps-2-trillion-mistake-2011-8
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