I may be the first blogger to defend the rating agencies this week. After I studied them and helped shape the rules which regulate them, I think this is a watershed moment. Standard & Poor’s took one of the bravest actions that I’ve ever seen a rater take when it downgraded the United States one notch. Furthermore, this marks a new beginning for accurate credit analysis and truth in fixed-income markets. Keep speaking the truth, S&P. Stand up and sing it out!
It’s been somewhat disconcerting to see the river of recent articles bashing the credit rating agencies after the downgrade. Raters aren’t perfect — after all they did prostitute themselves with their structured finance ratings that lead up to the August 2007 crash. For that, they deserve criticism. Strict new rules have been put in place since then that regulate them. Regardless, almost every article about the U.S. downgrade huffs and puffs about the legitimacy and fairness of a private company assigning an opinion about the creditworthiness of a sovereign entity.
S&P initially assigned their top rating of AAA to the United States in 1941 and had left it unchanged until last Friday. S&P is not paid for rating the United States. Even so, the decision to downgrade has been mocked as anti-American and uninformed. Unfortunately almost every person writing about this action couldn’t tell you how ratings are created, what they are used for or how raters are regulated. The lack of understanding is stunning.
The truth is that the U.S. deserved to be downgraded because the remedy to solve our fiscal problems is being blocked by political extremism. This is an indication of a governance breakdown and does nothing to assure those who lend us money that there is “full faith and credit” backing our debt and a rock solid intention to repay what we have borrowed.
Here is a video of one of the most powerful men in Congress, Representative Barney Frank, saying in July that he feared Congress could default on the debt. Then Congress and the administration took us to the brink of default and finally passed legislation at the 11th hour. What sane rater would look this and not question our willingness to pay? Add to those theatrics a debt load almost equal to GDP, plus massive liabilities for Medicare, Medicaid and war spending. It’s a picture of fiscal wantonness. No one is keeping our house in order. Standard & Poor’s just pointed to the emperor and said, “You have no clothes!”
Fixed-income investors value certainty above all else, and the recent debt debate blew their confidence in the U.S. as a steady, reliable borrower. Peter Fisher, who currently heads global fixed income at Blackrock, the world’s largest asset manager, says in the video above that he was giving speeches 8 years ago as a former assistant secretary of the Treasury about the poor fiscal condition of the U.S. In the video he explains numerous times how Blackrock positioned itself ahead of the downgrade to take advantage of it. There was no surprise at Blackrock. The only market surprise about the downgrade was that S&P had the strength to face off the world’s largest borrower and tell them they are no longer as strong and good-looking as they once were.
I’ll write another day about the regulation of credit ratings agencies. It will probably surprise most Muniland readers how well the rules allow them to be overseen by the SEC. The bad news is that although there are excellent rules Congress is strangling the SEC for funds. People’s anger should be directed at this Congress for starving our regulators when they should have all the ammunition they need to police all participants in the financial markets, including the raters. Then Wall Street’s overseer would have the resources to send some deputies around to make sure the raters have kept their houses in order.
Rater-bashing is a waste of time. Credit rating agencies will be powerful institutions as long as we have credit markets. Someone needs to rate large sovereign borrowers and tiny municipalities. It’s an industry with a long history in financial markets and a key role in developing opinions about creditworthiness. Bashing a rater for truth-telling is like punishing a child for speaking an unpleasant truth. It creates incentive to shade the truth, and the harsh truth is what is needed now more than ever.
Standard & Poor’s: Form NRSRO for 2011