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updated 4/18/2011 6:17:38 PM ET 2011-04-18T22:17:38

News that Standard & Poor's was cutting its outlook on U.S. debt rattled financial markets Monday.

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Cooler heads might recall that this is the same agency, along with Moody's Investors Service, that told investors that billions of dollars of securities tied to iffy home mortgages were safe bets — right before they collapsed and helped set off the biggest financial crisis since the 1930s.

"It's a sad state of affairs when one of the agencies that blew up housing is telling the U.S. to get its fiscal (affairs) in order," said money manager Michael Lewitt, who lashed out at high U.S. debt in his book "The Death of Capital."

"They're not wrong here, they're late," he said.

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S&P spokesman Catherine Mathis said the agencies were "very good" at rating government debt, citing a recent International Monetary Fund report. It found that all the government debt that defaulted since 1975 had received a rating of "non-investment grade," or what's called "junk," at least a year earlier.

S&P rates companies and governments by their ability to repay debt. The higher the rating — AAA is the highest — the lower interest they have to pay. Many mutual funds, pension funds and other big investors are restricted from buying debt below a certain rating from official credit raters. S&P is one of a handful of agencies designated as official raters by U.S. regulators.

The upshot: In deciding who gets to borrow, how much and how cheaply, S&P, Moody's and Fitch Ratings, another big rater, wield enormous power.

After the housing crash, some critics dismissed ratings agencies as useless. But they still move markets. S&P's opinion on Monday helped push down the Standard & Poor's 500 index 1.1 percent. Treasury prices initially fell on the news, but later recovered. The yield on the 10-year note fell to 3.38 percent from 3.41 percent late Friday.

In the European debt crisis, the raters have slashed the payback odds on various government bonds. Those moves reflected investor fears that the bonds could default, but they also helped spread them. Greece, Ireland and Portugal have had their ratings cut and are paying higher interest on their debt. Greece is paying 19 percent annually to borrow for two years, according to Lewitt. Last month, Moody's cut Spain's ratings a notch to Aa2, still investment grade. Speculation is rife that it may need a bailout from the European Union.

Critics say raters are likely to err on the side of optimism when reviewing bonds because they are paid by companies selling bonds, not by those who buy them as was the case in the 1970s. According to a report published last week by the Senate Permanent Subcommittee on Investigations, raters delayed slashing their ratings on disastrous mortgage securities for fear of angering banks the banks that were marketing them. One of the authors, Democratic Sen. Carl Levin, has said that this model is akin to allowing one of the parties in a court case to pay the salary of the judge.

S&P's Mathis said getting issuers to pay, not customers, is best because it allows ratings to then be distributed to all investors for free, resulting in more "transparent" markets.

Copyright 2011 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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