Comments on: Is it time to abolish the triple-A rating? A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: DavidMerkel Tue, 26 Jul 2011 19:14:40 +0000 Felix, you beat me. As I read your article, I was thinking, this is the reverse of Spinal Tap “It goes to 11.” and then you write:

Taking the triple-A out of the ratings universe would, at one level, be purely cosmetic. It would be like removing the pinstripes from the Yankees’ uniform, or changing the markings on Nigel Tufnel’s guitar amp so that they only go to 10 rather than 11.

If we didn’t have AAA and lower ratings to help the regulators with credit risk monitoring, they’d have to invest something worse to replace it, like the NAIC SVO.

By: rogueecon Tue, 26 Jul 2011 17:45:11 +0000 “But why the heck would they want to raise money in the US? They aren’t investing here”

That about sums it up. And why indeed would they raise money in another currency, to exchange into USD, when foreigners will know to charge a higher rate if they know the proceeds will go into USD, and will be paid back by a company earning in USD.

By: TFF Tue, 26 Jul 2011 16:52:37 +0000 “Perhaps multinational US companies will just raise money abroad where country risk is better rated than in US.”

Quite possibly. If people lose faith in the dollar, then dollar-denominated debt becomes very costly. The multinationals could then choose to write bonds in Euros, yen, or renminbi. Some do that already.

“But what does this mean for them if they want to still raise money in the US?”

They can borrow money in another currency, then exchange it for dollars. But why the heck would they want to raise money in the US? They aren’t investing here…

For that matter, the top-rated multinationals don’t NEED to borrow money at all. They only choose to do so because it is cheaper than equity. J&J, for example, has $9B of long-term debt outstanding. They have some $11B of net cash and $14B of free cash flow. They could pay off every penny of their outstanding debt over a two-year period and still make their dividend. Should their access to cheap borrowing be choked off, they will do exactly that. (Maybe not quite so abruptly — their bonds don’t mature THAT rapidly.)

I suppose you can imagine a scenario in which J&J is forced into default, but we will see hundreds of other corporations (and regimes) topple before that comes to pass. Is this truly more likely than Tea Partiers winning control of Congress and deciding that they don’t care to honor the national debt?

Only reason that J&J debt trades at higher yields than US Treasury debt is that the latter is more liquid.

By: rogueecon Tue, 26 Jul 2011 15:25:05 +0000 “The large “US based companies” do most of their business overseas. “

Quite right, and this might actually mean a seachange in raters’ perception that a company is subject to a specific country risk. So what does this mean if US government debt gets downgraded? Perhaps multinational US companies will just raise money abroad where country risk is better rated than in US.

But what does this mean for them if they want to still raise money in the US? US banks, US money managers, US intermediaries, all use US currency, expect to be paid in US currency, and by US banks backed by US government. Won’t the lower rated sovereign still affect the dynamics (and the perceived risk) of US financings?

By: TFF Tue, 26 Jul 2011 13:52:53 +0000 “If the US government losses AAA, then so will all US based companies.”

The large “US based companies” do most of their business overseas. They may report in dollars (as do some companies that are NOT based in the US), but most of their revenues and much of their expenses are in other currencies.

Some might even benefit from a crashing dollar, since overseas revenues exceed overseas expenses? In a strong-dollar environment you see regular notes about adverse currency impact on their earnings.

By: rogueecon Tue, 26 Jul 2011 13:42:01 +0000 As has been mentioned, there is no way corporates are going to have better ratings than the government that issues their currency, and backs their banks. If the US government losses AAA, then so will all US based companies. All AAA companies will go down a notch, and so will all AAs and As, and so on down. If this results in higher borrowing rates for these companies, there’s not much they can do other than domiciling themselves in some other AAA rated country.

By: Danny_Black Tue, 26 Jul 2011 04:51:03 +0000 For some reason you ignored the real reason AAA is so important and that is due to regulation – you know the regulation that apparently doesn’t exist. A significant portion of investors have severe limitations on what they can buy. They are not too lazy or överworked to look at other bonds, they usually cannot buy them hence the tranching and structured products business. For instance UK Pension funds did not think that a notional yield of 3.48% was a great punt for a 50 year gilt but because of the way pension fund liabilities were regulated, magically anyone who bought a 50 year gilt at ANY price who consider more solvent and better funded which reduced the amount the sponsors had to put into the fund. That is a real cash incentive for companies to do something stupid whilst knowing it is stupid.

The ratings are written into virtually every single derivative contract, again due to regulation. Ratings are written in capital regulation. They are written into most loan covenants. All of which are positive feedback triggers waiting to send a company or country into a death spiral once they hit an arbitrary barrier. Due to their pervasiveness it is hard to see how they could be removed.

PS dedalus, VaR is a requirement for regulation. It is not the banks who were using it to ignore risks rather it was the way the regulators were measuring risk and so the banks paid alot of attention to it, because again there was a cash reward for managing this figure.

By: Kamekon Tue, 26 Jul 2011 03:06:19 +0000 “Because everybody believes Treasury bonds to be risk-free”. Not really: glish/pr/show.php?id=102&table=web_e_zxz x

By: petertemplar Tue, 26 Jul 2011 02:08:50 +0000 Honestly, the day Treasuries are a risky investment is the day I’m more worried about surviving my new Mad Max existence.

This whole ceiling debate is a complete fabrication.

This is like starving in a room full of food.

And the United States doesn’t “borrow” money from anybody. Who gives a rat’s ass what Moody’s thinks?

By: dedalus Tue, 26 Jul 2011 01:56:36 +0000 Felix, your post reminds me of something you told the FCIC:

“Value-at-risk (VAR) was a way of allowing banks to ignore the tails. And the Gaussian copula function was a way of allowing banks to shove enormous amounts of risk into those tails. And when you put the two together, it’s absolutely disastrous.” terviews#S

So, if AAA-ratings are the current means by which tail-risks are priced too cheaply (consciously or not), to where is that tail-risk being shoved?