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S&P Vs. Moody’s: When It Comes To Credit Ratings, S&P Has Stumbled (Badly) Before

The reasoning behind S&P’s downgrade of the U.S. sovereign credit rating wasn’t whether the U.S paid its debts, which of course it has; the focus was on the process and problems in getting the temporary deal done. Simultaneously, Moody’s ratings agency decided that the U.S. still warranted a AAA credit rating and it maintained that rating accordingly. Who’s right?

Incredible. in cred i ble (in’ kred’e bel) adjective 1. Impossible to believe.

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Incredible is the only word to adequately describe financial phenomenon we have just witnessed. This week will be forever etched in history as the week the Standard & Poor’s credit ratings agency downgraded the United States sovereign credit rating to a AA rating from its previously untarnished AAA rating. This effectively made the creditworthiness of the U.S. less than France’s and on par with Italy’s. The reasoning behind the downgrade wasn’t whether the U.S. paid its debts, which of course it has; the focus was on the process and problems in getting the temporary deal done. Simultaneously, Moody’s ratings agency decided that the U.S. still warranted a AAA credit rating and it maintained that rating accordingly.

How could these agencies come up with such wildly divergent ratings? Both Moody’s and Standard & Poor’s ratings agencies are members of the NRSRO (Nationally Recognized Statistical Rating Organization). The first question that comes to mind is, since they are part of an organization: Are there standards and protocols that the agencies must use in their determination of ratings? Or are those ratings subject to the moods of the analysts and therefore subject to political bias? For those of you used to reading my formulaic, highly quantitative and historical number-laced articles and blog posts–please forgive me and their absence along with the obvious puns in those last lines. That being said, the premise behind the ruminations is completely relevant.

All personal musings aside, for whatever reason the credit markets completely disagreed with Standard & Poor’s and continued to value U.S. sovereign credit at the highest end of its spectrum with actual investors obviously valuing the ability to pay far greater than the analysts assessment. The storied investor Warren Buffett also commented on U.S. credit and stated
that if “Quadruple A” existed, that U.S. was worthy of that rating. Mr. Buffett also proclaimed in highly technical economic jargon that the S&P rating “doesn’t make sense.” Heretofore, Mr. Buffet has often been called the greatest investor ever. I wonder how much consideration will be given to the weight of that moniker and his considerable investment track record in light of this latest proclamation. 

To a large degree, the move by S&P could be construed as political, as many pundits will state emphatically. And in fact, the S&P itself cited political strife as one of the factors in the downgrade (its research update stated that it had “changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics anytime soon”). 

This consideration should be
given some weight, especially given that the underlying fundamentals remain
unchanged in the United States. Political pundits on the Right are quick to point out the courage of the ratings agency to outline fundamental issues with the process and leadership. Pundits on the Left have outlined the Tea Party extremists’ desire to hold America hostage until they get what they want and neglect their responsibilities to govern in exchange for bargaining power with a process not designed for those measures. The awful truth of the matter is that this crisis was manufactured in Washington, D.C., between the two warring factions and that the ensuing market meltdown was the byproduct of those machinations. One of the worst days ever for the Dow and Nasdaq will be
the legacy and testament of this downgrade of the U.S. credit rating.

Ironic as it may seem, I believe that S&P has been resoundingly consistent. Standard & Poor’s was, of course, one of the key ratings agencies that bestowed many of the highly exotic subprime debt issuances and collateralized debt obligations with higher credit ratings than they deserved. Those incorrect credit ratings resulted into one of the world’s greatest financial crisis and ensuing market malaise. It would seem that they have once again managed to pass a rating that will have dramatically negative
effects on the global financial marketplace.

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Remarkably, the securities that Standard & Poor’s downgrade was supposed to have the most dramatic effect on–U.S. Treasuries–watched their trajectory increase as investors piled into them as a safe-haven investment. The flight of investors to U.S. Treasuries was counter to the S&P’s ratings change and most likely not the desired effect that they intended with the downgrade. It’s quite possible that the market guaged the prospects of the U.S. to pay its bills in the future and discounted the difficulties in the previous process to get the deal done.

The defenders of Standard & Poor’s might say look to the future and don’t focus on the past mistakes of the ratings agency. As you might recall, the leadership of the firm graciously offered their deepest and sincerest
apologies for getting the subprime and other exotic debt ratings wrong. However, looking to the future would be counter to what S&P itself is doing, since it isn’t reviewing the financial outlook of U.S. credit from the present and has decided to focus on the process to get to this point. Conventional wisdom would lead most to agree that the sovereign credit of the U.S. was not remotely on par with Italy. Obviously the market sages at S&P have proudly disagreed with that notion; only time will tell if they were prescient.

If, however, S&P is once again wrong in their ratings analysis and that consequentially yields to more catastrophic events in the financial markets, we will be able to take solace and comfort that once again the leadership of S&P will be ready to offer their deepest and sincerest apologies for any market misinterpretations and miscalculations. Sine Qua Non.

[Image: Flickr user I .. C .. U]

About the author

Shawn D. Baldwin is Chairman of the AIA Group (AIA), an alternative investment and advisory firm based in Chicago.

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