Yves Smith at Naked Capitalism (an unusually good source of very in-depth, timely commentary) offers some strong evidence and analysis of how the S&P decision to downgrade the U.S. debt stinks.  I’ve already talked about how it’s really irrelevant at the economic level and how it’s not likely to change things substantially.  I’ve also written about how S&P doesn’t have a very good track record.

But Yves, who has extensive connections on Wall Street and in the trading/banking community, brings two other aspects to light. First, this downgrade, along with the threatened downgrade of a few state governments earlier this past week, was leaked before the announcement.  The proper procedure is to make such announcements after the close of markets and to not allow any leaks.  Leaks constitute insider information.  They let selected individuals make profits because they know what’s coming.  For example, as Yves suggests, if some traders or banks or others were told in advance, even just a few hours ahead that a downgrade announcement would be made, they could make millions.  How?  They could either place orders, particularly using derivatives, in anticipation of the move.  After the prices of bonds change due to the announcement, you sell.  But there’s a simpler way.  Just place an investment bet using the derivatives that based on the volume of trading.  Any announcement is certain to trigger a higher volume of trading.  Leaking news of announcements is an easy way for S&P to enrich it’s favorite friends. Yves notes:

Treasury yields fell 50 basis points last week despite the risk of a downgrade being very well telegraphed. S&P had asked for $4 trillion in deficit reductions (it tried disavowing that number) and made it clear it was going off to brood and might take action. And this market response took place with S&P leaking like a sieve. Not only was Twitter alight early on Friday with rumors of the downgrade, but some parties purportedly got the memo earlier in the week. From a credible source via e-mail:

Good friend passed on a note from a hedge-funder who thinks the S&P not only fudged its figures for today’s downgrade, but leaked it in-advance earlier this week to a few hedge fund insiders who made a killing off it. That would square with the fake “states face bankruptcy” panic scam earlier this year, which made a few people a lot of fast money.

I assume they did not make a directional bet but went long vol.

So what if bond yields go up 50 basis points on Monday, which is normally a monster move? It just puts us back to where we were last Monday.

So why didn’t investors dump Treasuries with this threat hanging over the market’s head? Maybe investors have wised up and realize the ratings are worthless (more on that shortly).

Yves goes on to explain a bigger, stinkier aspect to the downgrade.  It’s politics and a possible we’ll-help-Republicans-if-they-protect-us deal between Republicans and S&P.

Jane Hamsher highlights the hypocrisy of the S&P rating, since it shifted from its 2010 rationale of demographic stress to a February 2011 focus on entitlements. And it didn’t bat an eye at the $2.6 trillion deficit-increasing Bush tax cut extension at year end 2010. More from Hamsher:

Neither Moody’s nor Fitch downgraded US debt at this time. And S&P can’t quite come up with a consistent answer about why they are out there by themselves. It’s like they looked at a public opinion poll, decided that there was no way anyone would argue with “partisan bickering” as a justification, and crossed their fingers that nobody would actually question what it is that they were justifying.

S&P is playing footsie with the Republicans, who are passing bills to relieve them of the legal liabilities that Dodd-Frank exposes them to — even as the SEC is investigating S&P for fraud in the mortgage meltdown.

Some said that S&P wouldn’t dare downgrade the US debt. But it was all over four days ago when Pimco’s Mohammed El-Erian said that S&P was “under pressure” on the US rating.

If you didn’t happen to catch Devan Sharma’s testimony before the House Financial Services Committee last week, this was what he said:

As Dodd-Frank rulemaking progresses, we believe it is critical that new regulations preserve the ability of NRSROs to make their own analytical decisions without fear that those decisions will be later second-guessed if the future does not turn out to be as anticipate or that in publishing a potential controversial view, they will expose themselves to regulatory retaliation.

Pressures of that sort could only undermine the significant progress we believe has been made over the years by rating agencies and regulators alike to provide the market with transparent, quality and generally independent views about the credit-worthiness of issuers and their securities. I thank you for the opportunity to participate in the hearing and I would be happy to answer any questions you may have.

“Pressure.”

That’s what Rep. Randy Neugebauer, chairman of the House Financial Services Subcommittee said on April 29, when he requested documents from the administration: Treasury officials “may have exerted too much pressure on S&P.” The Republicans were already laying the tracks for S&P’s defense in April.

Here are a few more dots to connect the timeline:

April 18: Mitt Romney: “The Obama presidency was downgraded today.”
April 20: Mitt Romney: “Standard & Poor’s, one of the rating agencies, just downgraded their view of the future for America…If you will, they downgraded the Obama presidency.”
July 15: WSJ — “The Obama downgrade.”

They’ve been cooking this one for a while. S&P will defend themselves from the accusation of overt partisan manipulation by claiming the Treasury “pressured” them not to downgrade US debt. The media will focus on what Geithner did or didn’t say during his meetings with S&P in March and April. Nobody will ask about the ridiculous excuses S&P has made for the downgrades, or the fact that they are trying to wreck the American economy just as they did the British economy by playing God with their austerity prescriptions.

People are focused on the market implications of the downgrade, but that isn’t what this is about. It’s about a President who will now be relentlessly tagged with responsibility for a rating given by a disgraced organization whose victims should have liquidated them long ago.

As Politico reported, White House officials feared a downgrade more than they feared default.

This stinks.  I have only quoted the a small part of this story.  I urge readers to go to nakedCapitalism and read the whole article.  This whole downgrade by S&P is politics.  S&P is being used (quite enthusiastically with their cooperation) by bankers and politicians who desire to dismantle the social democratic state.