Posts Tagged ‘ratings agencies’

The only downgrade that matters

22 December 2012

Remember these words: “means of extinguishment.” The full quote is “The creation of debt should always be accompanied with the means of extinguishment,” and it’s from Alexander Hamilton, the father of our national debt. Hamilton believed that the federal government could do the nation a big favor by carrying a debt as long as it had sufficient revenue streams to eventually pay it off; such an arrangement, he said, would give the US “immortal credit,” which could come in very handy whenever we had pressing needs or good public investment opportunities that justified borrowing more money.

This has been on my mind because the (yawn) “fiscal cliff” negotiations, whatever their outcome, are really just the latest round in an endless series of self-destructive battles over whether to honor our own budget commitments by raising the debt ceiling so that we can pay for them. I’ve written about Congress’s debt-ceiling looniness before, and how it would be better not to have such votes at all. Think the proposed budget has too big a deficit? Fine, then don’t vote for it. But to vote for it and then refuse to pay for it is not only cynical and hypocritical, but sows suspicion that the government is a deadbeat.

Standard & Poor’s (S&P) famously downgraded the federal government’s debt in August 2011 (from AAA to AA+), and the other two major bond rating agencies (Moody’s, Fitch) are threatening to do the same if Congress can’t reach some kind of agreement to reduce the debt/GDP ratio in the long term. After the subprime scandal, in which the rating agencies routinely rubber-stamped dodgy subprime mortgage-backed securities as AAA, these agencies have zero credibility, but that doesn’t mean they’re always wrong. The S&P said its downgrade “was pretty much motivated by all of the debate about the raising of the debt ceiling. . . . It involved a level of brinksmanship greater than what we had expected earlier in the year.” Yes — if Congress can’t be counted upon to honor its own commitments, which include paying back the principal and interest on previously issued Treasury bonds, then why should bond buyers regard Treasury bonds as completely safe? The more Congress continues to play these games, the more rational it is to conclude that maybe Treasury bonds are not so safe. (more…)

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Ratingzzz

6 August 2011

For years I taught money and banking under the impression that U.S. Treasury bonds carried no rating at all. I thought they didn’t need to be rated and that the rating agencies agreed. I thought the fact that bondholders accepted lower interest rates on Treasuries than on any other bonds, even AAA-rated bonds of other entities, meant they regarded T-bonds as the least risky (and most liquid) bonds out there. A related issue is whether there’s any point in rating the debt of national governments whose finances are an open book, unlike those of corporations who open their books for the rating agencies but don’t have to for the public.

Standard & Poor’s downgrading last night of Treasuries from AAA to AA+ reminded me of all that. Do bondholders really need S&P, Moody’s, and Fitch to tell them whether T-bonds are safe? Anybody who follows the U.S. fiscal news  — e.g., anyone in the bond market — would have their own judgment on the matter. Call me cynical, but I find the timing of the announcement suspicious. First, it comes rather late, as it was clear five days ago that the Budget Control Act of 2011 was going to pass and what the substance of it would be. Second, it comes at the start of the weekend, two days before the markets reopen; that’s plenty of time for other news to come along and offset whatever effect S&P’s announcement has on the markets. My cynical hunch is that S&P is afraid the announcement will have no effect on the T-bond market, thereby underscoring their own credibility rating, which has been F ever since it came to light in 2008 that they’d been rubber stamping toxic bundles of subprime mortgages as AAA. I think their announcement is their way of gambling that if the T-bond market ever does go south, they can say they called it first. (Kind of like those ridiculous predictions every week on “The McLaughlin Group.”)

As usual, Krugman nails it. He acknowledges that the intransigence of Congressional Republicans makes any kind of meaningful long-term debt deal unlikely, but says:

‘On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

‘Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.’

In passing the Budget Control Act, Washington lawmakers put deficit reduction ahead of job creation, against the wishes of the public, Keynesian economists, and even (apparently) the stock market. Yet it wasn’t enough for S&P, who say the way out of this hole is to dig even deeper. No, S&P, slashing spending and raising taxes in a depression doesn’t improve our financial health. Krugman again:

‘More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. The agency has suggested that the downgrade depended on the size of agreed deficit reduction over the next decade, with $4 trillion apparently the magic number. Yet US solvency depends hardly at all on what happens in the near or even medium term: an extra trillion in debt adds only a fraction of a percent of GDP to future interest costs, so a couple of trillion more or less barely signifies in the long term. What matters is the longer-term prospect, which in turn mainly depends on health care costs.

‘So what was S&P even talking about? Presumably they had some theory that restraint now is an indicator of the future — but there’s no good reason to believe that theory, and for sure S&P has no authority to make that kind of vague political judgment.

‘In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.’

Ironically, the U.S. attained its AAA rating in 1941, just as we were heading into World War II and the (publicly held) national debt was about to explode, to about 140% of GDP, roughly double what it is now. S&P evidently took the long view then.