The politics of rating the USA

By Felix Salmon
May 22, 2009

When I said yesterday that any S&P downgrade of the USA “would be entirely political”, I was referring not to US politics but rather to the internal politics of S&P and even of McGraw-Hill, its parent: my guess is that no such decision would be made without the explicit consent not only of McGraw-Hill’s CEO but even of its board.

If you want proof that US sovereign ratings say everything about the rating agency and much less about the US, here it is coming straight from the horse’s mouth:

SR Rating, a Brazilian firm, will soon issue a judgment on American government bonds. Its verdict is not pretty: the company says it will issue a AA rating.

Paulo Rabello de Castro, who chairs the ratings committee at SR, describes the decision to rate Uncle Sam as “an outright provocation”.

Not that de Castro doesn’t make sense:

Mr de Castro argues that perfect scores should henceforth be saved for places like Norway that sit on lots of oil, put revenues from its sale into a piggy bank and are unlikely to be invaded by their neighbours. As for the structured products that were mistakenly given AAA ratings over the past few years, he argues that no asset that has been around for less than ten years should be considered worthy of the accolade.

This is uncontroversial stuff: even Moody’s has come out and said that Norway is more creditworthy than the USA. But the fact is that the US sovereign rating is so imbued with symbolism, especially since the Treasury-bond rate being considered the risk-free rate of return, that it can never be taken at face value.

Comments
5 comments so far

“In the absence of robust statistical testing, sovereign creditworthiness remains a
relatively subjective concept The limited predictability of economic behavior in general
and of political developments in particular leaves the task of credit ratings assessment poorly
suited to formulaic straight)ackets. As a result, S&P, Moody’s, and Fitch have over time
developed decision-making methodologies that blend objective, numerical analysis with
subjective, informed debate.”

http://www.uoit.ca/sas/International%20F inance/SovereignCredit.pdf

I found the paper that I read when I wanted to find out how countries are rated for risk. It is way too subjective for my taste to be left in the hands of credit ratings agencies. Having said that, they do seem to matter.

Here’s a quote from another post I’d bookmarked:

“So what’s an investor to do? “I think that ratings should be used as one of several sources by investors,” says Nangle. “Having a rating agency worried about how far they are from consensus is not useful. Credit ratings would be most useful if they were accurate predictors of the probability of default and were a long way from market consensus.”

Adds Sammut: “In theory, it should ultimately be up to the investor (to decide) whether the ratings are accurate.”

I think their view is nonsensical. The rating should be about the likelihood of default. I might screw my nose up at the spending patterns of Elton John, but I don’t think he’ll fail to pay his credit car bills. This just seems like anti-Americanism to me, the Treasury is not going to default and the idea that it’ll default before Norway is surely bonkers.

Posted by Matthewq | Report as abusive

Felix,

Where on earth did you get that a rating of the US would involve McGraw-Hill’s CEO and board? There are internal rules for rating committees and records are kept, incase the SEC or someone else asks for them, and there is no room for a board member to vote on such a matter.

the rating agencies have a totally inconsistent framework for sovereign ratings.
On one side, they set up some locally based joint ventures, which rate the local currency denominated govt automatically as Aaa, which I can understand as it can print money to service those debt.
However, separately from the headquarters of Moody’s/S&P, they give totally different ratings to countries on Local currency vs Foreign currency.
Case in point:
Mexico has Baa1 from Moodys’ on both local and foreign debt, despite having its own currency.
Japan gets Aaa from foreign debt while it’s Aa2 from Moody’s.

In my view, US can print money. its USD debt rating should be Aaa. its foreign debt should be rated lower.

Posted by CB | Report as abusive

CB,

You are confusing two separate things. National scales, which is what international rating agencies use within certain countries are not the same as the international scale you have in mind.

Another common error is to think that countries don’t default on their own currency. In fact, they do. A lot.

Tv

Posted by Gabriel | Report as abusive
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