Credit ratings agencies in crosshairs after U.S. downgrade

McClatchy NewspapersAugust 8, 2011 

WASHINGTON_ The Obama administration's response to the downgrade of the U.S. credit rating has been nearly identical to that of other countries that have suffered the ignominious hit to their reputations: attacking the messenger. In doing so, the administration is arguing that the United States is different from the rest of the world.

Is it? Yes and no.

It's different because it's home to the world's reserve currency, the dollar, and every day investors around the globe reaffirm it as the safest place to do business. It's why, paradoxically, investors fled to the safety of Treasury bonds Monday as financial markets skidded everywhere.

"One of the ironic aspects of this is there has been a flight to quality. ... It's ironic that it precipitated a flight to treasuries," said Jim Nadler, the president of Kroll Bond Rating Agency, a start-up competitor to Standard & Poor's on some ratings.

If that doesn't prove how little a credit downgrade matters in the near term, consider what's been happening in the market for credit-default swaps. Those are the insurance-like bets that were at the center of the U.S. financial meltdown in September and October 2008.

Credit-default swaps involve bets about the chances that a bond will default, and investors in these markets continue to consider the chance of the U.S. government defaulting on its bonds as less probable than France, Canada or other developed economies doing so.

In public and private conversations, Treasury Secretary Timothy Geithner and others in the Obama administration argued that S&P shouldn't have downgraded the United States because its economy and role as the center of the financial world make it different.

Like many a nation before it, Washington attacked the rating agency to deflect the message.

"I think S&P's shown really terrible judgment and they've handled themselves very poorly and they've shown a stunning lack of knowledge about basic U.S. fiscal budget math," Geithner told NBC on Sunday. "And I think they drew exactly the wrong conclusion."

Late Monday, Senate Banking Committee Chairman Tim Johnson, D-S.D., joined the chorus.

"This irresponsible move by S&P may, however, have spillover effects that tax the American people by increasing interest rates on home loans, credit cards and car loans, and by increasing the cost of finance for some state and local governments. I am deeply disappointed in S&P's decision to enter into the game of political punditry," Johnson said in a statement.

It all rings familiar to Vincent Truglia, who for years headed government bond ratings for Moody's Investors Service.

"I've been in the country risk business for over 34 years, was in the rating business 15 years, and I want to tell you that the other governments, when there was a downgrade, always attacked the rating agency," said Truglia, who's now an independent consultant. "It's really quite normal for countries to attack the ratings agencies."

He recalled that when Australia was downgraded, government officials were banned from ever talking to a Moody's credit analyst. Japan hauled a Moody's official in front of the legislature, the first foreigner to appear before lawmakers in decades. An Italian president took to the airwaves in the 1990s to declare that Moody's was part of an international conspiracy to destabilize the country.

Last week's downgrade by Standard & Poor's was justified, Truglia said.

"It's telling you that the economy and governance of fiscal policy is at issue. And I don't think anyone will disagree that there is a serious problem in fiscal-policy governance," he said, pointing to the last-minute deal last Tuesday to extend the debt ceiling. "It was a fiasco, an embarrassment that the U.S. government was carrying on in that manner. From my point of view, S&P did the right thing."

Friday night's action by S&P — knocking down the AAA gold-plated rating that U.S. bonds have enjoyed for 70 years to a notch lower, AA-plus — was controversial for many reasons. Chief among them was the tarnished view many average Americans have of the credit-rating agencies, who collectively played a major role in the financial crisis of 2008.

Reporting by McClatchy in 2009 showed how Moody's let business from Wall Street investment banks unduly influence ratings outcomes, with disastrous consequences for investors and the global economy. Part of the problem was a business model in which the issuer of the bonds traditionally pays for the rating, an inherent conflict of interest.

That ethics breach, however, didn't appear to spill over into the ratings for the bonds issued by countries around the globe. And the credit ratings issued for government bonds mostly have stood the test of time, proving accurate indicators of default risks.

S&P wasn't even the first to downgrade U.S. bonds. A smaller respected firm — Haverford, Pa.-based Egan-Jones Ratings Co. — downgraded U.S. bonds on July 16 from AAA to AA.

"We are taking a negative action not based on the delay in raising the debt ceiling but rather our concern about the high level of debt to GDP," the company wrote at the time. Egan-Jones calculates the debt differently

In an interview Monday, Managing Director Sean Egan noted that his company's rating was based on current and projected ratios of debt to the size of the economy, while S&P's action contained a huge mathematical error and was based on the perception of political intransigence.

"Our view is different than theirs in a sense that in a democracy, we welcome the debate, that oftentimes a better solution is ultimately derived as a result from the ordinary discourse that takes place in a well-functioning economy," said Egan, whose firm is paid by investors, not bond issuers.

Nadler of Kroll Bond Rating Agency, which doesn't rate government bonds, was more critical of S&P's action, claiming that the rating agency crossed a dangerous "don't go there" line when it signaled in April that anything less than a debt reduction of $4 trillion over 10 years would be insufficient to avoid a downgrade.

"I think the concern is that when you become part of the process, you lose your objectivity, and I think SP for the last month or so ... probably longer, has inserted itself into the politics and I think at that point it's very difficult to be an objective observer," Nadler said.

Egan is more sympathetic to S&P.

"I think Congress was looking for some guidance for what was needed for S&P to avoid taking action, and they threw out a number," he said. "In retrospect, that may have been a mistake. Once they threw it out, they were stuck between a rock and a hard place."

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