The Standard and Poor’s decision to strip the U.S. of its AAA rating down to a to an AA+ rating sent U.S. stock markets back into a flurry, falling below the 12,000 mark, but slowly climbing back this week. The downgrade is a first, and market watchers are still trying to figure it out.
Although the S&P’s rating got all the media attention, there are actually three top agencies that deal in credit ratings for the investment world Moody’s, S&P and Fitch IBCA. Each of these agencies provides a rating system to help investors determine the risk associated with investing in a specific company, investing instrument or market.
Moody’s and Fitch IBCA both confirmed their Triple-A rating on the U.S. government’s debt after legislation to lift the debt limit and reduce the deficit finally secured passage.
Although reaffirming the AAA rating, Moody’s said its outlook is now negative on the United States, saying a downgrade would be in order if the federal government’s fiscal discipline weakens in 2012, if additional “fiscal consolidation measures” aren’t adopted in 2013, if the economic outlook worsens significantly or if the government’s funding costs rise well beyond current expectations.
Moody’s rating seemed to give the U.S. a break, while the S&P’s took a stronger, perhaps political stand. Nearly everyone, it seems, has an opinion on the S&P’s decision from believing it was the right one, that might put a little shock into Congress and the Whitehouse, that they’ve got to stop spending more than they have, to others suggesting that the S&P was irresponsible in their assessment of the government’s ability to pay its bills. Even though S&P made a $2 trillion mistake in the estimate of the U.S. deficit when making their decision, they refused to back away from their downgrade putting much stock in the political scrabbling in Congress.
Patrick Emerson, author of the Oregon Economics Blog and an associate professor of economics at Oregon State University, commented on his blog last week that the S&P’s downgrade was meaningless. He said there is no new information out there that they revealed, they simply gave their opinion about the chance of a U.S. default which is slightly higher now that Washington has revealed a new and higher level of dysfunction. He said the S&P statement was a political avowal, not an economic one.
Emerson suggested that the markets crashed because of the global economic situation, the threat of a new recession and the debt ceiling’s new spending cuts. He pointed to investors “shedding equities and gobbling up U.S. Treasuries, driving the 10-year T-Bill yield to a new yearly low. This is the very security the S&P just downgraded – which demonstrates just how meaningless the S&P’s action was in that sense.”
Emerson blogged that we shouldn’t take the markets’ downturn as any evidence of an impending return to recession and in fact, “I don’t think it matters whether we return to slightly negative growth or stay with anemic positive growth: both imply unacceptable levels of long-term high unemployment.”
It sounds like S&P’s decision is not so much about America’s ability to repay its government debts but more about the continued failure of policymakers to get their arms around the problems undermining growth, employment, financial soundness and prosperity.
Could S&P have a grudge with the government? In April, Sen. Carl Levin, D-Mich., issued a scathing 650-page report contending that malfeasance at ratings bureaus like Standard & Poor’s was as much to blame for the housing bubble as any bank and suggested the firms knew they were profiting from unethical behavior. S&P gave Lehman’s Bros. an AAA rating just before its collapse.
A little-known section of the Dodd-Frank financial reform bill hits the rating agencies with new limits destined to undercut their lucrative business; the Securities and Exchange Commission is discussing how to implement the new rules.
The Dodd-Frank bill includes a series of measures that attempt to curtail the conflict of interest that is pervasive in the ratings world. For the first time, the SEC can actually decertify a ratings agency for allowing profit motives to influence ratings. It also strips the agencies of their long-treasured legal immunity from making mistakes. Before Dodd-Frank, it was essentially impossible for investors to sue over blatant ratings errors, like that ones that were common during the housing bubble. Now, ratings firms can be found liable if an investor proves they were reckless or knew the ratings were inaccurate.
Perhaps it’s time that the lucrative and once-traditional business of granting credit ratings be drastically revamped. For years, federal agencies and Congress have made attempts to reform the credit ratings business, which seems incongruous: part accountancy, part cheerleader, part judge and jury of the financial system.
Presently businesses that hope to borrow money from the bond market seek out a seal of approval from S&P, Moody’s and Fitch, and pay considerably for it. The firms say they isolate fee collection from ratings judgment, but the business model is the definition of a conflict of interest — and the firms’ actions during the height of the housing bubble call into question their ability to keep the ratings business free of profit-driven influence.
Levin’s report includes testimony from former employees who say they felt pressure to grant top ratings to new bond issues, lest they lose deals to competitors. In fact, the housing bubble was very, very good for the ratings agencies – Standard & Poor’s fees from mortgage-related bond issues quadrupled from $64 million to $265 million between 2002 and 2006, the report said.
But regulating the credit agencies has proven to be a near-impossible task. Not only are they intertwined in almost every corner of the market, they are intertwined with government agencies, too. Most state pension funds, for example, require that their managers only invest in funds with high ratings, which acts as a de facto endorsement of the agencies’ work.
Enough about S&P, they’ve gotten a lot of attention from their downgrade and many believe it was meaningless anyway. This may be a good time to step away from the fiasco in Washington and the market and focus on our own economic recovery.
The next media interest will turn to the debt-limit deal, which called for a nearly $1 trillion down payment on deficit cutting, and instructed a special congressional committee to draw up a blueprint for another $1 trillion-plus by November. We can only hope that the committee can put its political and ideological differences aside and get us on a long-term fiscal recovery. pha
