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AUGUST 8, 2011 3:02PM

Is the Downgrade of US Debt Another Miss by S&P?

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Warren Buffett speaking to a group of students...

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By now, everyone who's been paying attention knows that S&P downgraded US debt from AAA to AA+.  We won't take a position on the politics involved.  However, in order to solve the problem, it's clear that sacred cows will have to be sacrificed on both the revenue and spending side.  The two political parties are pretending that their favorite candy to their base can be left alone, but that's just not true.  Both are going to have to give up something or it just won't work.

Let's ignore that for a while.  The question we want to know is whether S&P knows what it's doing.  First, they made a $2 trillion mistake.  That's not a trivial mistake, even in a $15 trillion economy.

There are many who said that S&P made a mistake.  The two ratings agencies that compete against S&P for business, Moody's and Fitch, have maintained their AAA ratings for US debt.  And Warren Buffett said that US debt should be rated "quadruple A" and said that S&P made a mistake beyond it's $2 trillion mathematical error.

While our words don't have the same weight as Warren Buffett's -- nor should they -- we'd like to add our voice to that chorus.

First, when you make a $2 trillion mistake in your analysis, something that's only about 13 percent of GDP, that's an indication that your analysis may be flawed.  Second, we need to look at the track record of S&P. 

Remember AIG?  You should, since you own a piece of it.  Before it became obvious to everyone that the company was teetering, what was S&P's rating of it?  S&P gave AIG its highest rating as a counterparty.  Remember, AIG had written credit default swaps worth far more than it could ever hope to pay out and had done so for quite some time.  Yet S&P gave it the highest rating as a counterparty, thus fooling many into thinking, yeah, sure, I bought risky mortgage bonds but AIG's got my back.

And how about those risky mortgage bonds?  Through financial alchemy, somehow, financial lead in bonds based on mortgages of those with low credit scores and who put nothing down on their house was somehow turned into gold and given an AAA rating by S&P.  Yes, folks, S&P decided that a group of loans given to those with bad credit scores who may have lied about their income were somehow more likely to return full value to purchasers than debt of a country that's never defaulted.

Who else did S&P mess up on?  It's a who's who list of financial catastrophe and failure.  Enron, just a few months before its total implosion and filing for bankruptcy, was given an investment grade ratingGlobal Crossing was rated investment grade in March 2002 and then defaulted on its loans in July.  Worldcom is another example from that era.  And then we can throw in, just to pile on, Bear Stearns and Lehman.  In November 2007, Bear Stearns was given an investment grade rating.  It imploded in the spring of 2008.  And in the spring of 2008, Lehman held an investment grade rating.  We all know what happened to it in the fall of 2008.

The markets also think that S&P is wrong.  You'd think that the treasury would plunge given the downgrade.  Nope.  Yields on the 10 year, as we write this, have actually gone DOWN, which shows that investors don't agree with S&P's assessment.

In our view, S&P has a credibility problem.  Its track record of missing some of the worst financial shenanigans in history makes us skeptical to begin with.  Throw in a $2 trillion mistake, and it's even harder to believe them.

We'll side with people like Warren Buffett over S&P, and it's very likely we'll be proven right.  If two world wars, the Great Depression, the civil war, and the assassinations of Presidents Lincoln, Garfield, McKinley, and Kennedy couldn't cause the US to default on its debt, it's unlikely that a bunch of goofballs in Congress can.

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