Of course there has been a lot of discussion around the blogs and MSM about the S&P downgrade of the US. And the discussion keeps coming, hard to keep up with!
So, let me add to the discussion/noise.
There has been a lot of criticism of many aspects of the decision, and of the ratings agencies themselves … ‘corrupt’ is a description coming up a lot …. And I think 99% of this criticism is fair and reasonable; but leaving aside the question of the credibility of the messenger, what about the message itself? There has been a lot of criticism of this decision as an assessment of political risk rather than an assessment of credit worthiness. I want to turn to this.
In their statement S&P said, in part:
The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips
So, an assessment was made on political factors. Is this a reasonable way to go about making a sovereign debt assessment?
I am looking at it this way.
Lets imagine S&P (or any other rating agency) is examining a business firm, doing an assessment of say, Global MegaCorp (yeah, I made that up). Recently there have been new additions to the board of Global MegaCorp, and these new additions, while in the minority are very vocal and persistent in their view that it doesn’t matter if Global MegaCorp decides not to pay its creditors, its OK if the firm defaults on its payment obligations. A vocal and persistent number of shareholders have the same view, these are the shareholders who voted the new members onto the board.
The other members of the board, and the firm’s professional managers and staff, and the majority of shareholders are horrified by the views of this vocal and persistent minority. And, for now, these stakeholders are in the majority. But the reckless minority, as I have said, are very vocal and persistent, and entrenched in their ‘default doesn’t matter’ view. If their support is needed for some corporate action or other, the majority fear they may be forced to cave in to some of the reckless minority’s demands.
The bond holders of the corporation are staring to become concerned and turn to the ratings agency for advice. Now, ask yourself, what would a ratings agency do in this situation? What would be a legally responsible response? Would not some recognition of the potential danger be justified? Maybe, at the very least, a minor downgrade of the corporate rating? What would be the implications (including legal) of the agency ignoring this threat?
One other point, the rating firm Egan-Jones don’t attract headlines like the big 3 agencies, but Egan-Jones recently downgraded the US as well, well before S&P did. This hasn’t received much attention at all.