2011 US ratings downgrade — $2 trillion error, Jharkhand connection and spooked markets

Fitch downgrade of US sovereign rating wasn’t well received by the markets for obvious reasons. However, the reaction this time is significantly better when compared to the panic and fear that embroiled global equity and bond markets in August 2011, when S&P Global Ratings downgraded the US to AA+, a notch below the top rating of AAA.

US ratings downgrade: Is it 2011 dejavu for markets or ‘this time it’s different’?  US ratings downgrade: Is it 2011 dejavu for markets or ‘this time it’s different’?  

As it was a historic event then, given it was the first time the US had been downgraded, everyone from Barack Obama to Warren Buffet tried to quell fears, noting that there was no chance the US would ever default. Strangely, bond investors also thought so as amid the panic investors flocked to buy US government bonds, the very instrument whose credit worthiness had been questioned by S&P. The reason? Investors were, as it is, licking their wounds from the carnage caused by the global financial crisis of 2008, and fears of Eurozone debt crisis were escalating. In this context, the ratings downgrade spooked investor sentiment and aggravated panic among them, pushing them to take refuge in US government bonds. Equity markets globally bore the brunt of the downgrade. For example, the S&P 500 lost 8 per cent in just 2 days and the Nifty 50 4 per cent, when the downgrade happened.

• Also read: Equity markets slide on US downgrade

But last US downgrade was not just about the mayhem it caused, it was also notable for a glaring $-2 trillion error.  After S&P had submitted the documents to US Treasury in the morning of August 5, 2011, to alert them of the impending US ratings downgrade, the Treasury had quickly pointed out a massive $-2 trillion error in S&P’s calculation of estimates for US federal debt levels. S&P had quickly gone back to the drawing board, reworked its assumptions, but stuck to its downgrade decision, which it announced by end of the day.  This resulted in much bad blood spilling into the public with US Treasury going all out to criticize S&P for the downgrade despite the error. “A judgement flawed by a $2 -trillion error speaks for itself” was the comment from a US Treasury department spokesperson.

According to source-based media reports then, post identification of the error, S&P shifted the rationale for downgrade from economic to political. In its downgrade, it noted how the political divide had reduced confidence in government’s ability for much needed fiscal reforms. S&P’s response was that the error did not have any impact on the ratings decision given the political rationale.

• Also read: How Fitch rating downgrade flags US’ borrowing binge

Jharkhand connection

However, it was not just the markets that faced the casualty of the downgrade. There was some self inflicted wound as well. Jharkhand-born Indian American Deven Sharma, who had risen through the ranks of corporate America to become President of S&P and head of its ratings division, and hence considered the man who pressed the downgrade button, had to quit S&P just a month later.

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