S&P’s mistake: A lesson for actuaries

The Treasury Department outlines the $2 trillion error S&P made in its modeling of future U.S. budget deficits. It’s pretty basic. But the saga holds an important lesson for actuaries and other quants.

The Congressional Budget Office prepares two main scenarios of future budgets, with optimistic and pessimistic assumptions on government growth. Under the optimistic scenario, the budget grows relatively slow, and the debt-ceiling deal would save $2 trillion.

Under the pessimistic scenario, the budget grows faster, and the debt-ceiling deal would save $4 trillion. (There’s more available to cut, so more gets cut.)

S&P assumed the deal would only save $2 trillion under the pessimistic scenario – a $2 trillion error.

Thanks to that mistake – a big one – the heat is really coming down on S&P.

The Treasury Department – President Obama remains strangely silent  – blogs:

The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raise fundamental questions about the credibility and integrity of S&P’s ratings action.

Here’s USA Today:

Former Obama economic adviser Larry Summers, appearing on CNN’s State of the Union, said, “S & P’s track record has been terrible, and, as we’ve seen this weekend, their arithmetic is worse.”

Liberal economist Paul Krugman labeled the snafu “amateur hour,” adding “S&P stands revealed as not understanding basic analysis of budget estimates.”

But the error doesn’t make any difference in the downgrade. S&P asserts the downgrade is not a result of the model, but because the sturmundrang surrounding the deal showed that:

  • A relatively small faction – the Tea Party – was able to bring the government within hours of default.
  • Some Congressmen believe that a default would not be a big deal.
  • There were promises that the whole shenanigans would be repeated again and again indefinitely.

S&P is focused on the political problem, that in the medium-term the government might go crazy and refuse to pay bondholders. From CNN:

John Chambers, the head of sovereign ratings at S&P, told CNN that the political brinkmanship over the debt ceiling proved to be a key issue, with “the U.S. government getting to the last day before they had cash-management problems.”

And the error doesn’t change the conclusion of the analysis. U.S. deficits are projected to increase over the next decade under any scenario. Even Krugman acknowledges that the error doesn’t make much difference. (He thinks the U.S. deficit is manageable over the next decade. S&P clearly disagrees.)

For actuaries and other quants, the lesson is this: When you have a major presentation, make sure your numbers are accurate. Peer review, double-check, triple-check.

Because if there is a mistake, your opponents are going to jump on it with both feet, no matter how relevant the mistake is to the ensuing discussion.

P.S.: A WSJ story about the course of events is here.


One thought on “S&P’s mistake: A lesson for actuaries

  1. […] Update: Villains of the crisis here. More on the math error here. […]

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