S&P’s $2 Trillion Error

In the final hours before Friday’s historic downgrade, Standard & Poors gave Treasury an advance copy of its report. Amazingly, that report contained a $2 trillion error in its calculations of U.S. deficits and debt over the next decade. Here are four things you should know about it.

1. Treasury hoped that S&P would change its decision in light of the error, but S&P shrugged it off as not material. 

In a blog post, Acting Assistant Secretary for Economic Policy John Bellows described what happened when the error was discovered:

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.
On Saturday morning, S&P issued a clarification / rebuttal acknowledging the error, but downplaying its importance:

The primary focus [of our analysis] remained on the current level of debt, the trajectory of debt as a share of the economy, and the lack of apparent willingness of elected officials as a group to deal with the U.S. medium term fiscal outlook. None of these key factors was meaningfully affected by the assumption revisions to the assumed growth of discretionary outlays and thus had no impact on the rating decision.

2. Despite S&P’s claim, $2 trillion would “meaningfully affect” “the trajectory of debt as a share of the economy.”

It’s own revised calculations show net general government debt hitting 85% of gross domestic product in 2021 instead of 93%. That’s a big difference.

The 85% figure is still uncomfortably high and may well not deserve a AAA rating. But S&P was too dismissive in its clarification.

3. The error is understandable but remarkably sloppy for such an important analysis. 

The source of the error is painfully familiar to anyone who deals with U.S. budget projections. S&P’s analysts didn’t use the right measuring stick — i.e., the right budget baseline — when analyzing the effects of the recently-enacted Budget Control Act.

In one sense, it’s easy to see how this error happened. Budget discussions are now hopelessly confused by a profusion of different baseline projections of what spending and revenues will look like in the future. Indeed, I have devoted multiple posts to clarifying how different revenue baselines fit together (e.g., here and here). I’ve even used Johnny Depp to highlight the challenge.

A similar challenge exists with discretionary spending. Official budget baselines assume that annual appropriations (the defense and non-defense spending Congress fights over every year) grow with inflation unless subject to an explicit cap. That was the basis, for example, for the official baseline that the Congressional Budget Office used in evaluating the impacts of the Budget Control Act.

Before the BCA, there were no discretionary spending caps, so annual budget authority was assumed to grow with inflation from the most recent appropriated levels. The BCA then generated $917 billion in budget savings by setting annual spending caps below those levels.

S&P messed up because it based its analysis on another baseline. That “alternative fiscal scenario” assumes that discretionary spending grows at the same pace as the overall economy, not just with inflation. That baseline implies much more spending and debt over the next decade — $2 trillion more, in fact — than the official baseline.

So, again, it’s easy to see mechanically how this error happened. But it’s still remarkably sloppy. Budget experts are well-aware of the problem of multiple baselines. Indeed, we all pepper our conversations and analysis with the question “what baseline are you using?” It’s stunning that S&P didn’t have multiple analysts asking the same question to make sure their original numbers were right.

4. S&P’s response to the error further demonstrates that its primary concern about the United States is political not numerical. 

As S&P said in Friday’s report:

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a ‘AAA’ rating and with ‘AAA’ rated sovereign peers. In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging.

In short, S&P worries that America won’t get its act together in time.

22 thoughts on “S&P’s $2 Trillion Error”

  1. thanks for the information about this issue. if s&p makes this kind of mistake related to a government do you trust they’re not making mistakes in other things? why trust them or their analysis if they make these kinds of mistakes?

  2. S&P claimed that the error was much smaller, since they work on a five year ahead forecast and not ten years. Again, no excuse for such sloppiness and for changing their rationale when the numbers changed, but not as bad as the White House made it out to be. I think the post on Zero Hedge about “Equities in Dallas” for the G20 sovereign risk group was right on.

  3. It all boils down to which liars do you trust; the liars in the government or the liars at Standard & Poors?

    We know S&P do shoddy work and offer “optimistic”, ie AAA ratings for subprime junk mortgage backed securities just to get the business of the big banks. We know the government lies about everything from the bodycounts in our endless wars, to torture and infringement of civil liberties. The weekly unemployment numbers are a fairy tale as is most of the corporate media. 45 million people are on food stamps in this country, and yet we are not even in a recession according to the government and the media.

    We all struggle to walk ankle deep in lies. The government is floundering, No one appears to be in charge and no is in fact in charge. Our economic policy, our trade policy, our employment policy, our defense policy are all charades that share no data points with reality.

    I’m not about get bolluxed up about whether S&P had the numbers right because the numbers are manipulated and deceptive and likely wrong. The pattern of decline in our nation is quite apparent to any who will take the time to examine our true reality. The boarded up stores in every city, the homeless in tents or sleeping in the cars or under freeway bridges. The panhandlers at intersections. The states far from our southern borders teeming with Mexican and Central American migrants are very visual reminders of the failures of our government to deal with anything including protecting our borders and enforcing immigration law.

    Are we a AAA country?

  4. If I understand correctly, the Treasury has a legitimate grievance against S&P.

    It seems that S&P initially told Treasury that their upcoming downgrade was based “in part” (Treasury’s words http://www.treasury.gov/connect/blog/Pages/Just-the-Facts-SPs-2-Trillion-Mistake.aspx ) on their view that the deficit-reduction deal that was reached (the Budget Control Act) was only about $2 trillion in deficit-reduction rather than the $4 trillion in deficit–reduction that S&P saw as necessary to not be a factor/reason for downgrade.

    Treasury then pointed out an error S&P was making. S&P was assuming the $2 trillion in deficit-reduction was vs. a higher spending baseline than the actual baseline from which the $2 trillion was calculated. And the difference in those two baselines over 10 years is also about $2 trillion (just coincidentally). Which (seems to me) means that the projected deficits per the Budget Control Act actually WERE about $4 trillion lower than the baseline S&P had been using — i.e., the resulting projected debt (or debt/GDP) actually WAS at the level S&P had in mind as the level(s) necessary for that projection NOT to be a factor or reason for downgrade.

    So, unless I’m somehow misunderstanding, it sure seems that S&P has egg on its face not just for huge sloppiness but also quite possibly lack of integrity, unless it honestly believes that a factor they apparently initially cited as a significant factor in the downgrade really was superfluous — that even if that factor disappeared (as it seems to upon correction of their error), there is still enough reason to downgrade at this time.

    I’d welcome and appreciate any correction or confirmation of the above.

  5. hello Don nice to meet 2 weeks ago
    The Big three raters and S&P should be liquidated on behavior in past. that said
    you wrap up sayin “in short the S&P concludes that america wont get its act together in time” id be amazed if you did not agree, what do you think of the other two raters with US and the like of Fannie freddie still at AAA with them? all the little and good raters have already downgraded US
    1 why jump in with geithner in this “error” PR circus? treasury vs S&P cagefight! allows all the yahoos to avoid thinking. this actually reminds me of AIG today suing BoA/ countrywide . talk about one calling the other black.
    2. the elephant in the room is S&P contrary to the budget baseline assuming The bush tax cuts will be extended. Do you agree? what do you think the lilihood is of
    Rs holding the house–likely
    Obama losing –put your odds on.
    Senate Rs holding 61 seats-unlikely
    all three together most unllkely. Do you agree? Oops theres a $3+ trillion “error” vs baseline the other way.

  6. >In short, S&P worries that America won’t get its act together in time.

    Doesn’t everyone? Right now, the Democrats want to raise taxes on “the Rich” (a term I cannot find a definition for) while the Republicans want to cut spending but won’t be able to do so.

    One problem is the US Income Tax system does not take into account regional differences. If you make $150,000/year in New York City you are not really rich. If you make that in Bunny Kill, Alabama, you probably are.

    Look at a $300,000 house in Omaha and compare it with one in San Francisco. LOTS of differences.

    What the US should do is repeal the 16th Amendment and replace the Income Tax with a consumption tax. This would be harder to escape even for illegals.

  7. >the Democrats want to raise taxes on “the Rich” (a term I cannot find a definition for)

    Simply the use of English words for people in the upper 1-5% (5% = income over $145,283) of the income earners.

    >What the US should do is repeal the 16th Amendment and replace the Income Tax with a consumption tax.

    That would be horribly regressive and would benefit the rich because you only consume so much.

  8. This argument assumes that the CBO has a good record in forecasting US Government Budget outcomes some years ahead.

    The CBO does not have a good record.

    Instead some people prefer to shoot the messenger of bad news (i.e. S&P).

    It would be more helpful to listen to him.

  9. Still, S&P is silly. The US Government can print money. If I toss a Ben Franklin on the street, and no one wants it, then the US can default.

    Until then, it has the option of printing money.

    Which it should do, within reason. Moderate inflation for five to 10 years would cut the debt in half, relative the GDP. We ran moderate inflation in the USA through the 1980s and 1990s, and prospered. Why this is now such a big deal I do not know.

    The right wing has developed an obsession with minute rates of inflation, and an unhealthy affection for the symbols of wealth–gold and cash–not an appreciation of what is real wealth, and that is innovation, business investment and labor.

    The liberals should give on spending though, and the GOP on defense outlays.

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