So I’d like to talk a little bit today about the downgrade of the US’s credit rating by Standard and Poor’s. standard and poors announced recently that it has decided to downgrade the credit rating of the US gov’t from AAA, which is its top level rating, to AA+ which is one level below.
Standard and Poor’s is what’s known as a credit rating agency. So they’re an agency that issues credit ratings on the debt (and by debt we mean bonds), of governments and private corporations. And they issue these ratings as a guide for investors; to help them determine the relative safety of an investment. so basically, what credit ratings aim to help investors determine is the probability that an investment is going to be able to meet its obligations in the future. The higher an investment is rated the safer it’s considered to be. The lower an investment is rated, the riskier it’s considered to be.
A little background on S & P: they have been compiling and publishing statistical data on US companies since 1860. It has considered the US to be AAA rated since 1941. According to S & P, a AAA rating means that an issuer of debt has an extremely strong capacity to meet its financial commitments. It differs from a AA rating in that, an issuer of debt with a double AA rating is considered to have only a very strong capacity to meet its financial commitments. So the difference there is between extremely strong and very strong. The debt under a AA rating, is still considered high quality but according to the credit agencies, its susceptibility to long-term risks appears somewhat greater.
Now, the first question most people have upon hearing the news that S & P decided to downgrade the US is, why? What factors entered into the decision made by S & P? Well, apparently the debt ceiling debate of earlier this summer played a large role.
In an interview on CNN on the same evening the downgrade was announced, John Chambers who’s the head of sovereign ratings at S & P, gave an interview to CNN’s Anderson Cooper. (And that video can be found on the CNN website for those of you who would like to see it).
Anderson cooper asked Mr. Chambers, “Why did S & P downgrade the United State’s Credit Rating today?”
Mr. Chambers responded with the following, and I quote, “The political brinksmanship we saw over raising the debt ceiling was something that was really beyond our expectations. The US Gov’t getting to the last day before they had cash management problems. There are very few governments that separate the budget process from the debt authorization process. And we also think more broadly, that this debate has shown that although we do have an agreement that will, and we do believe will deliver at least $2.1 trillion of savings over the next decade. It’s going to be difficult to get beyond that, at least in the near term. And you do need to get beyond that to get to a point where the debt to GDP ratio is going to stabilize."
Anderson Cooper’s follow up question: “So it’s interesting, you’re saying without a doubt, the recent debate, the recent roadblocks in Congress, the tenor, the timing, the tone of the debate had a major impact on this?”
Mr. Chambers’ answer: “Yes, I think that is what put things over the brink.”
So without a doubt and without any ambiguity, Mr. Chambers is telling us that the length and tone and the vehemence of the debt ceiling debate played a large role in S & P’s decision to downgrade. He’s telling us that the way the debt ceiling debate was handled shook their confidence in the US government. And he’s telling us specifically, their confidence was shaken, not because of the size or amount or scope of the problems that we face. But rather because they no longer have confidence in the US’ ability to come together and produce the necessary solutions to these problems.
That’s the real danger in this type of negotiating strategy that’s being employed by our political parties. It’s not that deadlines will pass and problems will go unsolved and obligations will go unmet. Rather, it’s that we’ll begin to see steady erosion in the confidence in America’s ability to solve these problems. That we’ll begin to see a decline in America’s position as a psychological leader in the world. Our inability to put our nation’s interests ahead of our political party’s interests will lead to a perception of a lack of seriousness of purpose. It will make our politics, and our people, and our nation, seem petty. And ultimately, that will make us look weak.
America has held a position of leadership in the world over the past several decades because there is a belief in America’s ability to come up with big solutions to big problems. That in essence, we will always know what to do, and we’ll do it. The behavior we’re seeing these days is not consistent with that tradition. These petty squabbles and this partisan gridlock is not the behavior of a leader. True leadership lies in the execution of big ideas. It doesn’t lie in squabbling over them. And we need to get back to understanding that.
Now there’s a point here that needs to be made about S & P’s credibility. And that is this: S & P has been widely criticized for its role in the financial crisis of 2008. Many of the toxic assets that were packaged together and sold to investors by Wall Street were stamped with triple-A ratings by S & P, and rating agencies like them. The reason that’s significant is because these ratings play a major role in determining the appeal of these bonds to investors.
A bond that is rated triple-A is considered to be safer than safe. Those bonds have many interested buyers and are relatively easy to sell. Bonds that are rated lower are considered to be riskier investments. And so they attract less investors and investors who tend to be more speculative in nature. Those bonds are a little harder to sell. So to compensate for that fact, the bond issuer has to promise a higher rate of return, or a higher profit on the bond, in order to entice investors to buy them. That makes them more expensive to issue. So it’s in the issuer’s best interest to get they’re bonds rated as highly as possible. Because in many cases buyers are more attracted to the rating of the bond than to the bond itself. As financial journalists Bethany McLean and Joe Nocera put it so aptly in their 2010 book on the financial crisis, All the Devils Are Here, investors often don’t buy the bond, they buy the rating. So the rating is of paramount importance in the world of bonds.
So what role did S & P’s ratings play in the financial meltdown of 2008? Well, many of the subprime mortgages that went into default and triggered the crisis spiral were bundled into bonds that were stamped AAA by S & P and the other ratings agencies. And there’s strong evidence that suggests that the ratings agencies knew that the mortgages were not AAA credit worthy. At the very least, there is strong evidence to suggest that these agencies, of which S & P is one, did not do their due diligence in evaluating the underlying assets of these bonds. Even though they fully understood the weighty and substantial role that their ratings played in the buying and selling of these bonds.
So there you had a situation where many people believe S & P acted irresponsibly. And acted irresponsibly over a period of many years. And now here you have a situation where S&P seems almost eager to be out in front on this issue. No other ratings agency has followed suit in downgrading America’s credit rating. And not that that fact alone should preclude S & P from doing so, but it does illustrate that the decision to downgrade was far from an obvious one. It was far from a decision that the market would have regarded as odd had S & P decided not to make it.
The Dow did drop more than 600 points on the first day of trading after the downgrade was announced. But the biggest arbiter of the credit worthiness of the United States Government, the International Bond Market, basically shrugged their shoulders at the news. International demand for US Treasury Bonds dipped somewhat after the announcement but basically it went on unaffected. In other words, when it was time for investors to vote with their wallets, their opinion was made clear: US Treasury Bonds are one of the safest investments in existence. A point billionaire investor Warren Buffet seemed to be summing up when he quipped, “if there were a quadruple A rating, I’d give the US that.”
Many people are now accusing S & P of being less than patriotic for downgrading the govt’s credit rating. Now it’s hard to argue that S & P should have kept the US’ credit rating untouched solely out of patriotism, because it makes it sound as though one should expect S & P to be less than credible with its ratings. That they should be trusted to be objective with every other rating but not its home country’s. It also implies, even if unintentionally that a downgrade of the US’ rating would never be justified. That the US should remain Triple A worthy in the eyes of ratings agencies regardless of what the financial facts are. It should remain so merely because we are the United States.
Now expectations such as those would certainly be unreasonable. But most people, I think, are finding it difficult to not feel at least somewhat disappointed in S & P’s decision. As we’ve mentioned, no other agency felt it necessary to downgrade. And their concerns were completely countered by the market. So it leaves one wondering whether the decision was absolutely necessary. Is there a way S & P could have voiced these concerns, could have made them known in as public a way as would’ve been necessary to satisfy their dissatisfaction, without actually downgrading the rating? I think, the answer is yes.
There are real problems with the way our political system is tacking these days. This obstructionism and the gridlock it’s causing is doing plenty of harm, maybe more than we even realize at the moment. It would be hard to argue with that. But the downgrade, in my opinion, feels a little bit unnecessary. It feels as though S & P could have kept the rating as is, and not had that decision questioned in a serious way. But that they decided to go ahead with the downgrade anyway.
They have a point in that the brinksmanship that we witnessed over the debt ceiling debate was quite surprising. And was unlike anything that was expected. But you really wish S & P wasn’t in such a rush to nail the United States for it. You really wish a decision like that would be made only as a last resort, that is, only if it was near impossible to not make it and still be thought of as a legitimate decision. And the reason for that is because decisions like this, if they’re not made in that way, end up having the opposite effect than what is intended. Instead of being a serious decision that has a sobering effect on the discourse and on our politics, it is seen only as another bit in a long list of bad news and is only resented.
Maybe S & P felt it was necessary to be out in front on this issue because of the role that the firm played in the financial crisis? Perhaps they perceived this as an opportunity to prove their objectivity that was just too good to pass up? We don’t know for sure. But if it was, it seems to have not had the desired effect. There doesn’t seem to be too many people who feel more positively about S & P now, than they did before the downgrade. That’s the problem in sacrificing your principles. It sets you on a very tricky path in trying to navigate your way back to trustworthiness.
We are at a point now in our politics, and in the business of running this country, where leadership is needed on all levels, by everyone. S & P, along with the other ratings agencies, are not just arbiters of that leadership but are responsible partners in it as well. They are responsible for leading this country forward just as the rest of us are. It’s the shunning of that responsibility that led them astray during the run up to the financial crisis. They must not make the same mistake by going to other extreme. In the name of trying to regain that trust.