UC Berkeley alumnus discovers $2 trillion calculations error

A UC Berkeley alumnus found a $2 trillion calculation error used by a major credit rating agency to decide on a historical downgrade of the United States’ credit rating.

John Bellows, acting assistant secretary of economic policy at the U.S. Department of the Treasury who received his Ph.D. in economics in 2009, found the error Aug. 5, shortly after Standard & Poor’s presented a document to the treasury department with calculations it used to justify its unprecedented downgrade of the United States’ credit rating, from AAA to AA+.

“S&P’s $2 trillion mistake led to a very misleading picture of debt sustainability — the foundation for their initial judgment,” Bellows wrote in a blog post on the department’s website. “In their initial, incorrect estimates, S&P projected that the debt as a share of GDP would rise rapidly through the middle of the decade, and they cited this as a primary reason for a downgrade.”

The company’s decision was originally based primarily on the incorrectly calculated projection that overestimated the amount of public debt that will be a part of the nation’s gross domestic product in 10 years by $2 trillion. As a result, Standard & Poor’s concluded that this makes public debt — money that the government borrows through treasury securities and securities from other non-federal investors — very unstable and makes investing in the United States’ economy risky.

The company officially downgraded the nation’s credit rating on Aug. 5 after it was informed of the error by the treasury department earlier that same day.

The corrected estimates lowered the projection of future deficits by $2 trillion over the next 10 years and lowered the estimate of debt as a share of GDP by 8 percent, making public debt  much more stable.

After correcting its calculations, Standard & Poor’s said in a statement that the downgrade “reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.”

Additionally, the statement said that “the gulf between the political parties over fiscal policy” that deepened in late July when Congress began discussing the Budget Control Act of 2011 had reduced the company’s confidence in national leaders to handle the country’s finances and stabilize the debt.

In his blog post, Bellows said that there was no justifiable reason to downgrade the debt of the United States, independent of the error he caught.

“There are millions of investors around the globe that trade Treasury securities,” he said. “They assess our creditworthiness every minute of every day, and their collective judgment is that the U.S. has the means and political will to make good on its obligations.”

He maintained that because the company did not change its decision after the error was found and cited a lack of confidence in U.S. policymakers, the rationale behind the decision changed from being economic to political.

When stock markets reopened on Aug. 8 following the announcement of the downgrade, share prices around the world plunged but began to regain stability towards the end of the week. Markets continue to show signs of recovery into this week.

Because the markets are now stabilizing after the initial shock of the downgrade, it is unclear whether the new credit rating will have a big impact on markets in the long run, said Edward Miguel, a professor of economics at UC Berkeley.

“The credit rating agency did not tell us things that we did not already know,” he said. “Investors can now see that the S&P downgrade does not mean that fundamentals of United States economy will change.”