Tuesday, August 9, 2011

Breaking down the downgrade: distilling the message with visualizations and context.

Markets, both domestic and abroad, spent no time to react on the news that Standard & Poor’s, one of the three major companies that rate the solvency of nations, had downgraded the United States credit rating from AAA to AA+.

S&P released its report on the downgrade on Friday, Aug. 6, after American markets were closed. Overseas markets were the first to move, with Japan’s Nikkei index dropping 2.2 percent. A sell-off sent China’s mainland Shanghai market down 2.2 percent. The country’s Hang Seng index flirted with a 7 percent drop before settling down 4.5 percent for the day.

When it came time for America’s markets to open the following Monday, the Dow lost several hundred points in the first hour of trading, and ended down 512 points 4.3 percent. It was the biggest one-day drop since Dec. 1, 2008, the Wall Street Journal reported. It’s among the top 10 biggest one-day DIJA declines ever, the Journal wrote. Crude oil prices also fell amidst concerns about lower demand.

But what does the S&P report actually say? How can we distill and best represent it? The following word cloud identifies dominant words in the document, with the size of a word relating to its presence in the document.

As you can see, the dominant theme is “debt,” as in, “Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty.”

Another theme that jumps out from the word cloud is “long-term,” as in, “The outlook on the long-term rating is negative.”

Here’s another breakdown of the “debt” theme throughout the S&P report; a word-tree that shows the relationship between “debt” and other words. Clicking on the image will open another window where you can interact with the words.

From this, we can draw additional context. “Debt” is strongly linked to “burden” (which could just be another word for indebtedness) and “outlook negative.”

But there’s another word here that yields more interesting results: political. Again, click to interact with the visualization.

The word “political” is used 10 times in the document. The strongest things the S&P report has to say about politics in the matter of the U.S. credit downgrade comes in two sentences, one right after the other, located in the same paragraph:

“The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy,” Standard and Poor’s wrote. “Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently.”

So what is the political background for this document?

In a speech that broke on major networks during midday trading on Monday, President Obama criticized S&P’s downgrade, saying “No matter what some agency may say, we’ve always been and always will be a AAA country.”

Obama adviser David Axelrod, highlighting Republican obstructionism throughout the debt-ceiling talks, on national television called the S&P action “essentially a tea party downgrade.” “The tea party brought us to the brink of default,” he said on CBS’ Face the Nation.

Other high-profile Democrats echoed the same message. On NBC’s Meet the Press, Massachusetts Sen. John Kerry “This is the tea party downgrade because a minority of people in the House of Representatives countered even the will of many Republicans in the United States Senate who were prepared to do a bigger deal.”

Republican opponents seized an opportunity to grandstand and criticize the current Administration. Staffers for Mitt Romney, a forerunner in the GOP race for the presidency, told reporters that the former Massachusetts governor would attack Obama for the downgrade in a campaign speech.

A prepared speech for a recent campaign stop has Romney as saying “The president’s failure to put our nation’s fiscal and economic house in order has caused a massive loss of confidence that resulted in an embarrassing downgrade,” according to CNN.

However, the S&P report itself might be considered a political document; a chip played by a powerful player.

Standard & Poor’s is owned by the McGraw-Hill Companies, which better known for publishing educational books and trade journals. In 2010, it spent a company record of $1.65 million on lobbying, according to OpenSecrets.org.

According to records, it spent most of its time and money lobbying on financial issues. In 2010, if lobbied on at least 15 separate issues relating to financial regulation, including the Dodd Frank Wall Street Reform and Consumer Protection Act (H.R. 4173), which tightened regulations on credit rating agencies. (The specific requirements to credit rating agencies is in Subtitle C of Title IX of the law, also known as the Investor Protection and Securities Reform Act of 2010)

Lobbying by McGraw-Hill peaked in 2010, just as the
Wall Street reform act was being penned. Chart
is from OpenSecrets.org.

“The three major credit rating companies poised to decide whether to downgrade the nation's top-ranked debt standing are at the same time spending hundreds of thousands of dollars to lobby the Obama administration and Congress over the way the government regulates them,” the AP reported earlier in August.

McGraw-Hill wrote in its annual filing for the Security and Exchange Commission in 2010 that the new requirements may cost the company money.

“The Act also amended the law that establishes pleading standards in securities fraud suits brought against credit rating agencies under the Securities Exchange Act of 1934,” the company wrote. “The change in the pleading standards may result in increased litigation costs for the Company; however, the law does not amend the liability standard in such lawsuits which continues to be the same standard applicable to all defendants.”

McGraw-Hill spokespeople insist there’s a wall between the lobbying wing and the credit-rating wing of its operation. But analysts are concerned about a conflict of interest in the system, which has led some to question the credibility of S&P’s rating, and regard it as a kind of political move. Critics have pointed to S&P’s role in the housing and mortgage bubble, in which it gave high investment grades to risky, complicated financial instruments.

“S&P gave investment grade rating to hundreds of billions of dollars of mortgage backed securities They received tens of millions of dollars from the investment banks for these ratings,” the economist Dean Baker wrote.

“Does S&P think the U.S. government will forget how to print dollars? If that is not what the downgrade means then it would be helpful to explain what it does mean. Readers of this article would likely be confused since there is no obvious meaning that could be attached to this downgrade.”

One last visualization of the S&P downgrade shows the frequency of some key words. Again, click to expand and interact:

The entire S&P report is available here.