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As stock markets crash, consider what Standard and Poor's got right

Analysis: S&P's downgrade might be destructive and unpopular. Unfortunately, it wasn't entirely wrong.

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A trader reacts to the market downfall on the New York Stock Exchange, August10, 2011. US stocks plummeted, more than wiping out the gains of Tuesday's rebound. The Dow was down 519.83 points (4.62 percent) to 10,719.94 at closing, compared to its 430-point gain on Tuesday. (Stan Honda/AFP/Getty Images)

As global markets continue to tank, let’s vent some angst by listing valid reasons for trashing Standard and Poor’s, which downgraded U.S. government debt last Friday, catalyzing the crash.

For starters, there are the many inconsistencies in S&P’s work. As an outraged U.S. Treasury Department pointed out, a $2 trillion math error in its downgrade memo failed to change its conclusions.

In 2009, S&P projected that Washington’s debt would rise to 90 percent of gross domestic product by 2013, but it still reaffirmed America’s AAA status, as Bloomberg has reported. In its Aug. 5 2011 analysis, it foresees America’s debt level rising to a more manageable 85 percent of GDP in 2021 — but this rosier scenario nonetheless somehow warranted a downgrade. Go figure.

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And then there’s S&P’s grievous incompetence in the recent past. The agency rated Iceland’s debt a relatively safe A- until the brink of the country’s mammoth banking meltdown – the biggest such crisis ever, relative to the size of its economy. In other words, the agency failed to detect even the most massive of financial tsunamis.

In the U.S., S&P (along with rivals Fitch and Moody’s) were “key enablers of the [2008] financial meltdown,” according to Congress’s Financial Crisis Inquiry Commission. Deploying an inherently corrupt business model, S&P collected fat fees from investment banks in return for perfect ratings on mortgage backed securities that earned the banks a fortune — until these toxic assets knocked the banks and global economy to the mat.

As Jon Stewart points out, “Who’s going to listen to a company whose name translates to ‘average and below average” — a company that suggests you trust your money with the (AAA rated) Isle of Man before you give it to big, bad Uncle Sam.

There’s no doubt that S&P has earned the opprobrium. On the other hand, condemning the messenger is a knee jerk response, especially when the message delivered wipes out trillions in wealth around the globe. Similarly, in recent months European leaders have lashed out at S&P, Fitch and Moody’s as the agencies issue downgrade after downgrade on European debt — some commentators have even hinted at an American conspiracy (all of these firms are U.S.-based) and have floated the idea of a European alternative.

For certain, you can make a strong case that S&P makes massive blunders. But just because they’ve been wrong, often and dangerously, doesn’t mean they’re mistaken this time around.

As Michael Hirsh points out in the National Journal, S&P wasn’t alone in lowering its rating of U.S. In mid-July, Egan-Jones also downgraded the U.S. one notch, to AA+. Egan-Jones is small and relatively unknown, but its work is arguably of a higher quality: unlike the big three, the firm warned investors about toxic assets before the 2008 financial crisis.

Egan-Jones downgraded U.S. debt because, in its view, a virulently polarized Washington is not capable of tackling the challenge posed by the large and mounting debt. “I don’t think the political leaders have a handle on what [the] country is faced with. They still don’t understand the underlying factors,” Managing Director Sean Egan told Hirsch.

That, in fact, was essentially the same rationale that S&P deployed in downgrading the U.S.

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S&P stated that the “effectiveness, stability and predictability of American policymaking and political institutions have weakened” at a critical moment for the economy. The agency added that it was “pessimistic about the capacity of Congress and the administration to be able to leverage [the Aug. 2 debt ceiling agreement] into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.” It added, “the political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.”

Translation: America doesn’t deserve your unflinching trust because it’s fallen prey to political lunacy.

Let’s face it: That conclusion is hard to disagree with if you paid attention to the debt ceiling “debate” on Capital Hill — replete with Congressional pizza parties and Tea Party members turning to