“Curse you Standard & Poor’s!!!!”

“Curse you, Perry the Platypus” – Dr. Heinz Doofenshmirtz (of Doofenshmirtz Evil Incorporated), Phineas and Ferb

S&P made headlines at the tail end of last week by downgrading the US debt rating from AAA to AA+. Wow, is this worthy of comment. First, let us consider the necessary background of ratings agencies in general. Instead of writing on the subject, I’ll just grab the appropriate sections from Mike “Mish” Shedlock’s blog. Back to my thoughts in a moment, first, from Mish’s 2007 post “Time to Break up the Ratings Cartel“:

________

The rating agencies were originally research firms. They were paid by those looking to buy bonds or make loans to a company. If a rating company did poorly it lost business. If it did poorly too often it went out of business.

Low and behold the SEC came along in 1975 and ruined a perfectly viable business construct by mandating that debt be rated by a Nationally Recognized Statistical Rating Organization (NRSRO). It originally named seven such rating companies but the number fluctuated between 5 and 7 over the years.

Establishment of the NRSRO did three things (all bad):

1) It made it extremely difficult to become “nationally recognized” as a rating agency when all debt had to be rated by someone who was already nationally recognized.
2) In effect it created a nice monopoly for those in the designated group.
3) It turned upside down the model of who had to pay. Previously debt buyers would go to the ratings companies to know what they were buying. The new model was issuers of debt had to pay to get it rated or they couldn’t sell it. Of course this led to shopping around to see who would give the debt the highest rating.

The Solution is Amazingly Easy

Government sponsorship of organizations and intervention into free markets always creates these kinds of problems. The cure is not an executive shuffle, third party verification or half-measures and more regulation that mask over the issues by splitting functions within an organization. The SEC created this problem by creating the NRSRO. The problem is easily fixable. It’s time to break up the cartel by eliminating the rules that created it. Moody’s, Fitch, and the S&P should have to sink or swim by the accuracy of their ratings just like everyone else. Ratings would be a lot better if corporations had to live or die by them. Free market competition, not additional regulation is the cure.

________

So, point #1, made rather clearly by Mish – ratings agencies are not free market constructs any more, they are quasi-political organizations established into a cartel by the SEC (that is, the federal government, which is a government of, by, and for the people). They do not make a living based on quality of their performance, but based on quantity of ratings produced, and therefore have no real incentive to get it right at all. (You remember the subprime crisis, right?)

Point #2. Welcome to the party guys. Really, it took this latest round of debt-ceiling impasse for you to think that maybe, just maybe the US shouldn’t be AAA rated? If so, then please tell us the criteria on which you base the ratings. Did we ever miss a debt payment? Will we ever? (By the way, our debt is all denominated in dollars – a currency that we can print at will. We can pay the whole debt back in cash tomorrow … or, as long as it takes to print that much money.) So if we’ve never missed a payment and almost surely never will because we’ll never run out of dollars, why were we downgraded?

The doubter will object “but, that is the same as a default – you will have paid back less value by inflating the currency.” I agree; I agree totally. But if this is an accepted term for default (and I think it should be) then we should have been downgraded two or three decades ago, not just now.

Point #3. Some aspiring young politician should introduce legislation tomorrow requiring the SEC to kick S&P out of the ratings cartel. Don’t bite the hand that feeds you boys, it’s not smart. (For that matter, they should just crush the whole cartel, but when has freedom mattered to these guys?)

I don’t know what the market will do with this information – I would hope nothing. But, there are certainly investment funds out there that are required by law to only hold AAA rates securities – which means they’ll either have to dump US treasuries or claim they believe Moody’s & Fitch more than S&P. It would make for a rather nice thud though, if the market responded with a big yawn and slapped S&P upside the head (that’s right, I said “upside”).

This entry was posted in Uncategorized. Bookmark the permalink.

One Response to “Curse you Standard & Poor’s!!!!”

  1. Pingback: Defending Bear Rights … Oh, Wait | Freedom at Bethsaida

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s