Friday, May 22, 2009

US sovereign ratings say everything about the rating agency and much less about the US

From Reuters:

Felix Salmon

is summer arriving?

May 22nd, 2009

The politics of rating the USA

Posted by: Felix Salmon
Tags: credit ratings

When I said yesterday that any S&P downgrade of the USA “would be entirely political”, I was referring not to US politics but rather to the internal politics of S&P and even of McGraw-Hill, its parent: my guess is that no such decision would be made without the explicit consent not only of McGraw-Hill’s CEO but even of its board.

If you want proof that US sovereign ratings say everything about the rating agency and much less about the US, here it is coming straight from the horse’s mouth:

SR Rating, a Brazilian firm, will soon issue a judgment on American government bonds. Its verdict is not pretty: the company says it will issue a AA rating.

Paulo Rabello de Castro, who chairs the ratings committee at SR, describes the decision to rate Uncle Sam as “an outright provocation”.

Not that de Castro doesn’t make sense:

Mr de Castro argues that perfect scores should henceforth be saved for places like Norway that sit on lots of oil, put revenues from its sale into a piggy bank and are unlikely to be invaded by their neighbours. As for the structured products that were mistakenly given AAA ratings over the past few years, he argues that no asset that has been around for less than ten years should be considered worthy of the accolade.

This is uncontroversial stuff: even Moody’s has come out and said that Norway is more creditworthy than the USA. But the fact is that the US sovereign rating is so imbued with symbolism, especially since the Treasury-bond rate being considered the risk-free rate of return, that it can never be taken at face value."


“In the absence of robust statistical testing, sovereign creditworthiness remains a

relatively subjective concept The limited predictability of economic behavior in general
and of political developments in particular leaves the task of credit ratings assessment poorly
suited to formulaic straight)ackets. As a result, S&P, Moody’s, and Fitch have over time
developed decision-making methodologies that blend objective, numerical analysis with
subjective, informed debate.” inance/SovereignCredit.pdf

I found the paper that I read when I wanted to find out how countries are rated for risk. It is way too subjective for my taste to be left in the hands of credit ratings agencies. Having said that, they do seem to matter.

Here’s a quote from another post I’d bookmarked:

“So what’s an investor to do? “I think that ratings should be used as one of several sources by investors,” says Nangle. “Having a rating agency worried about how far they are from consensus is not useful. Credit ratings would be most useful if they were accurate predictors of the probability of default and were a long way from market consensus.”

Adds Sammut: “In theory, it should ultimately be up to the investor (to decide) whether the ratings are accurate.”

- Posted by Don the libertarian Democrat

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