Credit Rating Agency Nonsense

August 03, 2011   |   August 2011 Bond Updates
Are credit rating agencies born stupid, or is their particular brand of stupidity an acquired skill? Even after today's scurrilous debt ceiling deal was stampeded through Congress and signed by President Obama in less than 24 hours,  senior officials from credit rating agencies like Moody's, Standard & Poors, and Fitch have continued to issue dark warnings that US federal debt's AAA rating is still "under review," and that it soon may be downgraded to AA. Meanwhile, even as this debt hysteria has mounted, in the last two weeks average yields on US Treasury paper have plummeted to all-time lows. Indeed, nominal interest rates on US federal government debt are now at their  lowest levels since the Federal Reserve's comparable data series started in 1962. US real interest rates are the lowest ever. Since the median Treasury note outstanding has a maturity of less than 5 years, this means that Feds are now paying average rates of about 1.32 percent on new marginal debt.  And this rate has been headed down, not up -- exactly the opposite of what we'd expect if investors were worried about some kind of US debt default or fiscal debacle. True,  longer-term rates have not fallen as much, and the yield curve has steepened. But even 30-year Treasuries are now yielding less than 4 percent in nominal terms -- less than 2 percent in real terms. So what's going on here? Quite clearly, outside the Beltway's smoke-filled rooms  and the ratings agencies,  investors are breathing heavily, not about "big deficits," but  about the dismal outlook for economic growth at home and abroad. After all, investors don't have to hold their breath for pronunciamentos from ratings agency bureaucrats to assess credit risk or determine interest rates.  Financial markets do a pretty good job of repricing innumerable debt instruments every day. Furthermore,  as investors are well aware, the credit ratings agencies have a track record -- and it  is not pretty. For whatever reasons -- including some pretty outrageous conflicts of interest -- they have systematically under-predicted almost every major debt crisis that we've had in the last fifty years. The big misses included the Third World debt crises of the 1980s, the Japan debt crisis of the late 1980s, the Asian and Russian debt crises of 1997-99, the Argentine debt crisis of 2001-02, the global banking crisis of 2007-2009, and the Euro-debt crises of the last two years -- as well as private corporate debt fiascos like Enron and AIG. Now, badly burned by all these miscalled balls,  the umpires at credit agencies  have decided to call more strikes. From Eastern Europe and the "PIIGS" to the US federal government, and state and local governments,  they have recently been over-predicting one fiscal crisis after another,  demanding radical reductions in deficits. In the US, where the anti-tax movement has acquired a virtual embargo on any policy measures that might be interpreted as "tax increases" -- even the enforcement of the tax code -- this automatically translates into a radical reduction in spending. In the long run,  "living within your means" is of course a noble objective. In the short run it can be completely self-defeating.  As many economists have observed, "excessive debt" is a ratio, not an absolute -- it is defined relative to expected future income. If government policy-makers ignore the impact of spending cuts on growth, the bloodletting may kill the patient before there is ever a chance to "live within" anything.

View more at: http://blogs.forbes.com/jameshenry/2011/08/02/credit-rating-agency-nonsense/
 
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