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US Downgrade: Is S&P to Blame — or Congress?

Tuesday, 23 Aug 2011 | 5:53 AM ET

Deven Shama, the president of Standard & Poor’s, is to stand down next month and be replaced by Citibank COO Douglas Peterson.

Deven Sharma, president of Standard & Poor's, testifies before a subcommittee of the House Financial Services Committee in Washington, D.C., U.S., in July 2011.
Bloomberg | Getty Images
Deven Sharma, president of Standard & Poor's, testifies before a subcommittee of the House Financial Services Committee in Washington, D.C., U.S., in July 2011.

Following the decision by S&P analysts to strip the United States of its AAA debt rating, the ratings agency found itself at the center of a political storm that eclipsed even the criticism it faced following the U.S. subprime mortgage crisis. But there are voices, not just from within S&P but also without it, that say the United States — and Congress, in particular — got what it had coming to them.

“Is holding up default as a political weapon any way for a "AAA" country to act?” asked Marc Ostwald, a strategist at Monument Securities. Some members of Congress, in particular those from the "Tea Party" wing of the GOP, appeared to downplay the negative repurcussions of default for the U.S. and global economies.

Still, immediately after the downgrade, Tim Geithner told CNBC in early August that “S&P has shown really terrible judgment,” claiming they had “handled themselves very poorly” and going on to claim the group and its 1,300 analysts had “shown a stunning lack of knowledge about basic U.S. fiscal math.” See the video here.

Sharma then appeared on CNBC himself in order to defend the agency's decision-making. See the video here.

"Our role is to call the risks objectively, with transparency, and that's what we try to do to fulfill our role and that's what our job is for the benefit of investors,” Sharma said.

Sharma cited one such U.S. risk factor that, he said, had helped push the ratings agency toward its decision: He said the battle over raising thedebt ceiling — a three-month-long Congressional battle that was acrimonious even by Washington standards — had played a part in the decision to downgrade because it "speaks to how the fiscal, economic and monetary choices are being made”.

He's not alone in thinking Congress behaved poorly.

Sharma went on to defend S&P’s reform process following the industry’s failure to see the subprime debt crisis coming. He claimed the rating agency has "made many changes in putting new checks and balances in our organization. We are committed to the reform process".

The fact that Sharma has stood down from his job just a couple of weeks after the U.S. downgrade, has raised questions over whether he is being made into a scapegoat to deflect political pressure on the credit ratings agency.

“I particularly want to thank Deven for his dedicated leadership of S&P,” said his boss Terry McGraw Hill III in a statement. “Today, S&P is a stronger company, whose 1,300 global analysts are sharply focused on the quality, independence and transparency of S&P’s research and analytics."

The problem for S&P, according to Peter Toogood, the head of investment at Old Broad Street Research, is that when it came to the U.S. downgrade, the message was difficult to argue with but badly executed “They did get their math wrong,” he said.

“S&P was simply telling Congress to play nicely,” said Toogood, who believes the problem for S&P and its rivals is their previous poor performance. “These are the same people who rated the [collateralized debt obligations] as investment grade and missed the level of leverage at Lehman Brothers,” Toogood said in an interview with CNBC.com.

The other problem for the ratings agencies is their funding model, according to Toogood who rates funds and then gives them the option to pay for the license to the rating, if they want it. Typically, ratings agencies charge a fee from the very companies that they rate, and they do so in competition with one another — causing some to say that corporations can, essentially, shop for a rating.

“Governments do not pay for their ratings. Corporations do though. If you want to be rated then you have to pay for it,” said Toogood.

Others ask why anyone would listen to S&P and its ratings rivals in the first place.

“We all know the numbers on the U.S. debt. What difference does it make if S&P rates American debt as AAA or AA+? They will not default, as they can print their own money,” said Adrian Schmidt, an FX strategist at Lloyds Bank Corporate Markets.

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