What do bond raters want?
As everyone knows by now, the credit-rating agencies in New York have put the U.S. government on notice that it might lose its “AAA” debt grade. Somewhat less clear is why anyone should care: after all, these are the same characters who recently stamped three A’s on a huge pile of securities backed by subprime mortgages. Not only that: the U.S. fiscal predicament is perfectly obvious to any newspaper reader, so what special insight do Moody’s, Standard & Poor’s and Fitch bring to the subject?
My own theory is that investors are taking the ratings agencies seriously for two reasons: a) the problem has to be bad if Moody’s, et al. are finally waking up to it and b) they have to. A huge web of contracts and legal strictures requires money managers to allocate funds according to what the agencies say. This is supposed to change under the Dodd-Frank financial reform law, but regulators haven’t finished the job yet.
Meanwhile, no one can say exactly what the U.S. government has to do to please the ratings agencies. Back on July 14, S & P issued a report suggesting that it could reaffirm the AAA rating “if Congress and the Administration reach an agreement of about $4 trillion, and if we conclude that such an agreement would be enacted and maintained throughout the decade.” Conversely, “an inability to reach an agreement now” would be “inconsistent with a ‘AAA’ sovereign rating.”
No such deal is in the cards, so this would seem to mean curtains for the AAA rating. Yesterday, however, S & P’s president, Deven Sharma, seemed to waffle. The July 14 document had been “misquoted,” Sharma told a House subcommittee. “Since there was a $4 trillion number put forward by number of congressmen, as well as by the administration, our analyst was just commenting on those proposals, that that would bring the threshold within the range of what a AAA-rated sovereign debt would require,” he added.
That’s not the way the report reads to me, and I’m not the only one. But, whatever.
What’s really annoying here is how the ratings agencies’ unearned status enables them to serve up superficial, highly conventional political prognostication and call it credit analysis.
For example, the July 14 report argues that failure to cut a deal now, when the political system is “more focused” on debt reduction than it has been for “a decade” — possibly because the debt wasn’t so bad a decade, or even five years, ago? -- could mean that no deal would happen for several more years.
But that doesn’t necessarily follow. What if there’s a GOP sweep in 2012 and the Republicans actually succeed in imposing massive cuts? Or the Democrats win and impose a big tax hike on the rich? Or if there’s gridlock and the Bush tax cuts expire, yielding an instant revenue windfall?
And by the way, how meaningful is the AAA rating when France has one despite a debt-to-GDP ratio higher than that of the U.S., a decreasingly competitive economy, belligerent public-sector workers, liability for bailing out Greece, and a political system arguably even less capable of wrestling with long-term fiscal problems than that of the U.S.?
I could go on and on. But the bottom line is that the ratings agencies’ tough talk about the U.S. bond rating – to the extent they really do intend to follow through on it – probably has more to do with fighting the reputation for laxity they earned during the crash than with any special knowledge they might have regarding U.S. government finances.