The rating agencies are the whipping boys of the market. Like princes who had a whipping boy to take the hit for their transgressions, so the rating agencies take the hit that should go to the regulators, which delegated their credit-risk responsibility to the rating agencies. That works out well for all, in one sense: the rating agencies make money, and the regulators escape blame. What could be better?
But now we face another situation with the rating agencies, where they will finally downgrade the US Government from AAA. Long overdue, particularly when one looks at the entitlement promises.
But people put up all manner of objections to the rating agencies doing what they should have done ten years ago. Here is the big one:
The rating agencies never get it right
Not true. On corporate credit, their ratings are highly predictive, and even yield insights into the movement of stock prices. Now, if you are talking about securitized credit, you have to understand one thing: no one gets a debt market right until it has been through a failure cycle. The rating agencies use what little data exists, usually from loans that are held on-balance-sheet, and apply them to loans that are originated and sold. Doesn’t work that well, but who had better data, because it was a new practice? Everyone failed on securitization, and only a few of us questioned it in advance.
With government credit, the rating agencies have been right for the most part. Why? For the most part, rating agencies are honest dealers when it comes to credit. To be otherwise would damage their reputation.
Others talk about what the US or the EU could do to muzzle the rating agencies, because the downgrades complicate their actions. I would say that the Rating Agencies are late if anything — the agencies don’t have much impact on their own. The big impact is that not enough cash will flow to service debt and other demands on cash at the right time.
If the rating Agencies were muzzled, it would not change the cash flows one whit, except that there would be greater distrust from lenders, because the referees were forcibly silenced.
So what happens if the US gets downgraded?
Not much. As I have said before, the ratings don’t mean much, except to regulators. Yields shouldn’t move much, and if there is a sovereign ceiling at Aa2/AA, that will be the benchmark for all US yields, and corporate/municipal/securitized yields won’t shift much, because the economic reality hasn’t changed much.
What will change are investment guidelines that require Aaa/AAA investments. They will reflect the lower top category, and not force investors to buy foreign AAA dollar-denominated bonds.
What happens if the debt ceiling isn’t raised?
Not sure. There are lots of things that can happen:
- Prioritizing payments
- Not paying principal or interest on bonds (not likely)
- Issuing scrip (haven’t heard it yet, but who can tell, states have done it)
- Martial law is declared, and the Constitution is null and void (again, not likely)
A genuine full default by the US Government would have many ugly consequences, and should be avoided. Prioritizing payments would be ugly, but could force our government to do the hard questioning that it has avoided for a long time — what are the priorities of our government? What would we spend money on if we were deciding on priorities today, rather than the dead ideas of the past?
What, Me Worry?
I have concern over a lot of things, but the debt ceiling does not make it for me. The bigger entitlement issues have been ignored for 40 years, and I have covered them for 20 years. This is not the end, but the beginning of debates over where the resources of the US go, and how much is extracted from the populace. The real test will come when Medicare is reduced, and how well the voters accept that.