Blaming the messenger
Despite telegraphed warnings, Standard and Poor’s Friday evening downgrade of American debt stunned the world.
The credit rating agency attributed its decision to the controversy and outcome surrounding the debt ceiling debacle, and the expectation that raising revenues will remain “a contentious and fitful process”.
In short, S&P focused its sights on government dysfunctionality and bipartisan gridlock. And it’s no use looking to Moody’s current inaction as a foil. Moody’s takes a loss severity approach, looking at the overall expected losses in the event of any default. S&P, however, adopts a “first dollar” view, which considers the likelihood of a single dollar in loss. The downgrade expresses that, assuming future bumps and burps, America might cross into default, even briefly, causing a critical first dollar to be unpaid. Thus, the two agencies may share closer views than is commonly appreciated.
S&P faces heat. On Friday, the Treasury crowed when John Bellows, its acting assistant secretary, spotted a $2 trillion (€1.4 trillion) discrepancy that distorted the debt to GDP ratio for 2021, from 87% to 79%. The gap derived from Treasury’s reliance on a 10-year horizon, versus S&P’s 3-5 year window. Yet the credit rating agencies are probably more fearful right now of lawyers attacking their traditional freedom of speech prerogatives than of actuarial challenges.
All sides are vying to shoot the messenger, from the Chinese and Warren Buffett (both holders of Treasuries) to American political parties. Republicans wince, as S&P notes that “revenues have dropped down on the menu of policy options”, revenues being a euphemism for taxes. S&P scolded Democrats, too, for maintaining “only minor policy changes” in Medicare and other entitlements. “The credit rating agencies are meant to be apolitical,” says Sylvain Raynes, the founder of R&R Consulting. “They should stay on the side and do their job without passion or prejudice.”
Both politicians and public may call for blood, but abolishing the credit rating agencies will not help investors to determine value. Who would replace them? The answer, going back to the 1970’s, is internal assessment. “If you eliminate all ratings, you just move the field to a cowboy atmosphere, where people perform their own,” says Raynes.
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