Just the Facts: S&P's $2 Trillion Mistake

Just the Facts: S&P's $2 Trillion Mistake

By: John Bellows 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.

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Oh, my. Treasury has a fact sheet explaining that $2 trillion error by S&P; it may sound technical, but to anyone who follows budget issues, it’s a doozy.

When the Congressional Budget Office “scores” policies, it does so relative to a “baseline” — a set of assumptions about what would happen in the absence of that policy. The normal CBO baseline — mandated by Congress — assumes that discretionary spending will rise with inflation, but no more. This isn’t realistic most of the time, since the demands for government services rise both with growing population and in many cases with rising economic activity; that’s one reason CBO always provides an “alternative fiscal scenario” that’s supposed to be more realistic. Under current conditions, however, with Obama already committed, even before the debt deal, to fairly harsh austerity, the zero-real-growth baseline is more realistic — and it’s how the debt deal was scored.

But S&P initially assumed that the debt deal was subtracting off a quite different baseline.

The point here is not so much the $2 trillion, which makes very little difference to real US fiscal prospects; it’s the fact that S&P stands revealed as not understanding basic analysis of budget estimates. I mean, I don’t think I would have made that mistake; real budget experts, like the people at the Center on Budget and Policy Priorities, certainly wouldn’t have.

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