Why Treasury (and the Rest of Washington) Is So Furious at S&P

Derek Thompson Aug 7 2011, 12:46 PM ET

S&P made a big math mistake. We're in danger of making an even bigger one.

REUTERS

S&P's historic downgrade of U.S. debt was based on a $2 trillion math error, the Treasury Department said in a post published on the Department's website Saturday and emailed to reporters the same day.

For some perspective: $2 trillion is 14% of gross domestic product today, 8% of GDP in 2021, and more than a fifth of our projected debt accumulation in the next decade. It's the difference between the total cuts in the deal we got (including the supercommittee or trigger mechanism scheduled for the end of 2011) and a deal that most people agree would have averted downgrade altogether.

The math mistake comes down to what budget analysts call "baselines," or spending scenarios. The debt ceiling deal cuts $2 trillion under a scenario where domestic spending grows with inflation, but $4 trillion under a scenario where domestic spending grows faster, with nominal GDP. S&P acknowledged that it messed up by assigning the $2 trillion figure to the second baseline:

John Bellows, acting Assistant Secretary for Economic Policy, wrote that "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."

Treasury's right. S&P's math mistake was embarrassing. But politics was always a part of S&P's calculus. When I spoke with S&P global head of sovereign ratings, David Beers, he said he was looking for a sign that our political process was moving in the right direction. The government just spent the last two months threatening to technically default on the debt unless a minority of the minority party passed a measure to balance budgets in a recession.Talk about embarrassing.

International investors obviously disagree with S&P's analysis. Ten-yield yields are at historic lows. That's good for the U.S. government, good for home buyers, and good for domestic investment. We should all hope bond investors stare AA+ in the face Monday morning and say, "So what?" But we should also hope this downgrade forces grown-up Republicans to crack down on the anti-tax fanatics in their party and shakes Democrats into seeing that entitlement reform is a keystone to long-term deficit reduction. Not seeing that Medicare, Social Security and tax reform should be a part of deficit reduction would be the real math mistake.