[Editorial] S&P’s dubious downgrade

We’ll find out soon enough what the markets will make of the decision by Standard & Poor’s to downgrade its rating of U.S. sovereign debt to AA+ from AAA. But the early response from the people who matter most in the controversy ― the Asian and European nations that Hoover up Treasuries ― seems to show a score of: U.S. 1, S&P 0.

The playing down of the downgrade by officials in Japan, South Korea, Britain, Russia and elsewhere (China, the biggest purchaser, has been vague) was probably to be expected. After all, the value of a rating service comes when it digs deep into a corporate balance sheet and finds things that catch potential investors unawares. In this case, the budgetary shenanigans and political machinations of Washington are completely and embarrassingly out in the open, and S&P’s report didn’t contain one iota of information the public didn’t already know.

Rather, S&P’s explanation for the downgrade was entirely political, reflecting the company’s view that the “effectiveness, stability and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.”

The Treasury claims that S&P’s conclusion, which will likely cause the dollar to sink and push up domestic interest rates, stemmed in part from a “basic math” error involving $2 trillion in cumulative deficits. It is also clear the firm relied on two questionable assumptions: first, that the George W. Bush tax cuts are certain to be extended before they expire in 2012, which is anything but certain; and second, that one can predict with any sort of assurance where the political winds will lead us a decade from now. One wonders how S&P can so specifically predict a net U.S. debt-to-GDP ratio of 85 percent in 2021 just paragraphs after it laments the total lack of “predictability” in the nation’s political system.

That said, let’s look at the upside of S&P’s decision. We hope it will reinforce just how inadequate the debt-ceiling compromise was in terms of the long-term financial picture in the U.S. We wish the so-called supercommittee in Congress much luck in paring spending, but the $1.5 trillion in cuts it is supposed to find won’t make a significant dent in the federal debt.

Also, S&P’s entry into the political playing field should give further impetus to efforts, under the Dodd-Frank financial reform package, to end the overreliance on ratings from private firms in U.S. regulations and laws. Perhaps Washington can also take a closer look at the cozy relationship between the rating firms and the big banks that pay them while being subject to their scrutiny, which played no small role in the housing bubble.

We recently commended the rating services insofar as they are able to play a constructive role in the American and European debt crises. S&P’s downgrade decision did not clear that bar. But we give the report credit for highlighting a difficult political truth: at some point revenues must be enhanced, whether through raising taxes on the wealthy and middle class, reforming the tax code, instituting a national value-added tax or some combination thereof. If placing the full faith and credit of the U.S. on a par with that of Belgium ― a nation that has now gone 421 days without a government ― was necessary to drive that point home in Washington, we’ll owe S&P a debt of gratitude.

Editorial, Bloomberg