May 28, 2009
Moody’s Blows Smoke While S&P Brings The Mirrors
On May 18 Moody’s cut Japan’s foreign-currency debt grade from Aaa to Aa2. On May 21 S&P lowered its outlook on Britain to “negative” from “stable”. While both of these actions caught the markets by surprise it was of little surprise that speculation immediately ensued of a potential U.S. ratings downgrade. After all, anyone with a calculator and some common sense can readily surmise that with trillion-plus dollar deficits arriving just as Medicare, Medicaid, and Social Security costs threaten to devour all spending the outlook is potentially very ominous for the United States. Thus, if Moody’s and S&P are objectively fine-tuning their government debt ratings why not, at minimum, put the negative label on America?
One of the reasons why the rating agencies may be reluctant to downgrade the U.S. is because if rating cuts add volatility to an already volatile U.S. debt/interest rate situation Congress could turn considerably less friendly to the agencies. Remember, these are the same rating agencies that completely missed the Enron debacle, embraced the subprime era with triple-As, and thought that Lehman was still an ultra-safe bet before it filed for bankruptcy. It goes without saying that if Congress so desired it could launch investigations into the agencies and/or work to completely reshape what is tantamount to a conflict ridden business model.
Another similar reason why the agencies may be slow to change their viewpoint on U.S. debt is that the actual act of downgrading America could lead to financial market chaos which could then lead to further cuts and/or the rating agencies losing their relevancy. As Moody's Vice President Steven Hess noted in January 2008, “The US rating is the anchor of the world's financial system. If you have a downgrade, you have a problem.” Keeping in mind the idea of self-preservation, there is little for the rating agencies to gain by cutting U.S. debt and potentially much to be lost.
So instead of placing the U.S. on negative watch – something Moody’s threaten to do well before the current U.S. deficit nightmare took shape - Moody’s and company continue to play the role of cheerleader. Last week as S&P’s U.K. warning prompted managers like Bill Gross to warn that the U.S. could ‘eventually’ lose its triple-A, Mr. Hess followed Treasury Secretary Geithner in trying to assure the markets that all is well:
Of course we are continuing to watch U.S. government finances and there are some long-term threats to the U.S. government's financial position that we have to evaluate, but we don't see anything immediate. [bold added]
And this week with U.S. interest rates rising, the dollar falling, and more than $100 billion in Treasury notes expected to come to the market, Moody’s and S&P offered some more timely chants:
Even with a significant deterioration in the U.S. government's debt position, its rating has a stable outlook and demonstrates the attributes of a Aaa sovereign. Moody's
I want to make it very clear that the negative outlook on the U.K. is not a secret message to Washington. If we wanted to talk about the U.S. then we’d talk about the U.S. Moritz Kraemer, S&P’s head of sovereign ratings for Europe, Middle East and Africa
To reiterate, and as I am sure everyone is well aware, anyone with a calculator and common sense realizes that some very difficult and painful borrowing/spending choices must be made by U.S. policy makers if they hope to avoid sparking a dollar collapse. Even so, don’t expect the rating agencies to downgrade or even change their outlook for the U.S. so long as U.S. debt issuance (regardless of the size) continues to be met with demand. Rather, the rating agencies will continue to promote highly rated U.S. debt as an ‘anchor’ because doing anything less threatens to sink their own businesses.
In other words, the rating agencies - possibly receiving secretive phone-calls in the middle of the night – have become little more than a tool of the U.S. administration. And no matter how grim the outlook gets the smoke and mirrors show will continue until, and if, the failed auctions start piling up.
Mr. Hess (hypothetical): “While we should obviously be downgrading the U.S. we can not because a default is next to impossible so long as all U.S. debt is U.S. dollar denominated.”
Mr. Geithner (hypothetical): “Good point Hess. However, market participants, well aware of the U.S.’s printing press, may be more comforted by a smoke and mirrors display as opposed to these frank observations”
Remember, it the uniqueness of U.S. debt that makes seemingly absurd speculations from the supposedly objective rating agencies sound plausible, and makes nearly all of us (or anyone exposed to USD) hope that the show goes on...
Moody's said the dollar's status as a reserve currency played a crucial role in the country's continuing ability to fund its debts.