Perhaps, but according to the New York Times, the investigation began before S&P downgraded the U.S. -- but how long before? Remember S&P got the rating agency outrage ball rolling back in April. It was the first to question rising political risk in the U.S. as it revised the nation's debt outlook to negative. Moody's and Fitch followed with their own warnings, of course.
Even if this investigation was started before any of this downgraded business began, it is now hopelessly compromised. To the extent that those who have influence in Washington can push the Justice Department to go harder on S&P, they probably will. It's also worth noting that the other rating agencies -- which made just as terrible mistakes as S&P during the housing bubble -- are not known to be targets of similar investigations.
Municipalities Drop S&P
Some municipalities are clearly and directly retaliating against their downgrades stemming from the U.S. rating change. Los Angeles, for example, has dropped S&P from the group of agencies that rate its bonds. So have two other counties, with others considering similar moves. This will mean lost income for S&P, but the agency should have anticipated such potential consequences to its contrarian stance going in.
Lost Credibility With Other Issuers and Investors?
The bigger question for S&P's future prospects is whether or not the U.S. downgrade will have broader, lasting negative effects on its business. Losing fees from a handful of municipalities isn't going to break the firm. But if other issuers worry that S&P is becoming overly conservative in its rating approach, then they might also choose to turn to other agencies instead. We'll have to wait to see.
Investors' reaction has been somewhat mixed. After the U.S. was downgraded, Treasury yields dropped, which means that investors were willing to pay even more money for Treasuries. This is precisely the opposite of what would have occurred if investors had abandoned U.S. bonds due to the risk that S&P's downgrade attempted to highlight. Yet reports indicate that municipal bonds were affected more adversely.
So investors' view here is complex. Apparently, they must see the prospect of a U.S. default highly unlikely, despite the downgrade. But perhaps they believe that the U.S.'s poor fiscal position could result in a decision not to bail out municipalities that face default.
The Problem This Causes
The reactions of the federal and municipal governments are somewhat hypocritical. Back when Congress was holding hearings about all of the problems that we saw during the financial crisis, they loudly criticized lenders for cherry-picking rating agencies. They appeared deeply concerned that mortgage bond issuers pressured the agencies to provide overly optimistic ratings to ensure future business. Separately, some municipalities have criticized the agencies for not being conservative enough with their ratings, after the local governments lost money on mortgage bonds held by pension funds.