Saturday, August 6, 2011

U.S.A. Credit Rating Downgraded To Double-A Plus By S&P

Credit ratings issued by the credit rating agencies have an interesting history for me. I remember when I was first introduced to the whole credit rating system over 40 years ago. My first experience with credit ratings was in the municipal bond arena. Back then there was just the two big credit rating agencies that mattered, Moody's and Standard & Poor's (S&P). Moody's was considered the better rating for municipal debt and S&P was considered the better judge of corporate debt. There were also some smaller bond dealers that gave their own credit rating on municipal debt that they underwrote. I remember reading these credit rating reports and how one of the items mentioned was the percentage of white people and the percentage of black people that lived in the municipality under review. Later when I became a municipal bond investment officer with the trust department of one of the banks in Cincinnati, I would read credit rating reports on the debt offerings coming to market for the coming week. In reading about the debt coverage of the Puerto Rico Highway Authority bonds, I discovered that they had over 6 times coverage on their outstanding debt. One would think that 6 times coverage would certainly call for a rating higher than a single-A rating. To say that race played a role in determining credit worthiness of a debt issuer, in my opinion, is an understatement.

The downgrade by S&P for me and I am sure many others is suspect. The first question that comes to mind is: How influential were Republican Party operatives in pushing S&P to this conclusion? Credit ratings do not exist in a vacuum. There is always a lot of discussion, and, who was driving that discussion? Were people inside S&P pushing for this downgrade, or, was this downgrade politically motivated from outside the agency?

S&P has a history of being behind the curve on changing their credit ratings as well as giving higher credit ratings than deserved in the case of the mortgage-backed bond ratings which they so charitably gave triple-A. As the investment bankers would shop a rating from the credit rating agencies, the rating agencies knew where the growth in earnings was coming from in their business.

Yes, this downgrade will hurt the credit of the United States and our whole economy. It will mean higher interest rates for everyone. Lenders will jump on this like white on rice, and see it as an opportunity to raise their earnings too. Savers on the other hand should most likely see the interest rates on savings accounts, money market funds and certificate of deposits go higher. But, higher rates may discourage investments where the internal rate of return will not warrant the risks associated with new construction. That is a downside for our whole economy as well as the world's economy too.

This is not the end. The Congress could take action to raise revenues and that would certainly put us facing the right direction. Debt is rated not only by the issuer's ability to pay, which in the case of the United States is not in question, but also the willingness to pay, and here is the rub. Congress is viewed by their recent theatrics as not graciously willing to meet our fiscal obligations. Attitude plays a role in how we are viewed around the world also.


Butch said...

Thanks, as usual, when I need an answer I can count on you.

moneythoughts said...

Butch, glad you liked my posting about the downgrade of U.S. Treasuries. Certainly will give the REpublicans something to take aim with against Obama. And yet, this downgrade did not happen over night, the behavior over the last 10 years adds up.