Credit Ratings Agencies May Want to Tread Carefully

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It turns out that when you say things like "let's not pay back our debts, what's the worst thing that can happen?," one thing that does happen is that the credit ratings agencies start worrying that you might not pay back your debts. Weird. From Reuters:

Standard & Poor's has warned lawmakers privately that it would downgrade the country's debt if the Treasury Department is forced to prioritize payments because Congress does not raise the debt limit, a congressional aide said on Thursday.

That is, cutting off Social Security checks could avoid a technical default but not a downgrade. Moody's yesterday threw out its own threat of pre-default downgrade.

You know who else had ratings agencies all up in their shit threatening downgrades just because of massive fiscal and political-will problems? Europe. And they have some ideas on how to deal. Short version: insert fingers in ears, close eyes, hum noisily. Longer version:

Step 1. Point out that those jokers at Moody's have no idea what they're talking about anyway / declare opposite day

Greek PM George Papandreu in March:

We have seen the ratings agencies go from the bubble of euphoria to the panic of risk. Only two years ago they were rating AAA all the toxic bonds that created the crisis.

Okay, sort of fair - a lot of AAA RMBS didn't work out so well. And therefore, obviously, any downgrade of a sovereign just means that that sovereign's credit is great. Because everything a ratings agency does has to be the opposite of right.

Ron Paul is already hitting this theme in the U.S., saying (via ZH) that no one should care about the AAA rating since:

I think if you had a market evaluation on this issue, it should have marked down a long time ago. And you know I always wonder about these ratings. The bond ratings before the crash three years ago weren't very helpful.

Yes! The market clearly thinks U.S. debt is fucked, as demonstrated by the 2.9ish yield on the 10-year. His solution: have gold rate the U.S.'s credit.* You'd be surprised what gold can do if you just give it a chance. Ron Paul knows - gold washes his car, answers his phones and gives him back massages.

Step 2. Point out that they're foreigners and therefore not to be trusted

As European Commission President Jose Manuel Barroso said last week:

It seems strange that there is not a single rating agency coming from Europe. It shows there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe.

So, harder here what with Moody's and S&P being American. We could delegate this step to Maxine Waters - if you say that they're from the Cayman Islands, then maybe that makes it true? No? Try saying it again maybe.

Step 3. Ask who wanted them to rate securities anyway

The EU's latest idea is just not to let the agencies rate sovereigns who don't want to be rated because maybe they got a bailout from other EU members, or forgot their checkbooks today, or are getting over a bad breakup and just really don't need to deal with this right now okay? This after a plan last year to create a new, presumably friendlier government-run rating agency to take over the job of rating European bonds.

Maybe here we can get away with something less drastic. A reader points out that "Moody's is biting the hand that feeds it; the only reason these guys are around is because of the government regulation that enforces a oligopoly on bond rating agencies." Certainly true historically - although recent reforms, even before Dodd-Frank, did much to remove the legal support for the rating agency oligopoly without so far doing much to increase real interest in competitors to the big 3 or so agencies. But the agencies still have a lot of quasi-official power - including until recently a requirement that all structured issuances be rated - and with credit rating agency reform rulemaking still going on, there are a lot of potential reforms that could make their lives harder and less lucrative.

With so much blame to throw around, and with everyone in a tizzy about what to pack for the weekend at Camp David, we have not heard politicians go after the ratings agencies yet. But if there's an actual downgrade that affects the government's cost of borrowing, we wouldn't be too surprised to see some retaliatory tantrums bleed into the ratings agency debate.

* Really, watch the clip, he says that U.S. solvency should be rated by the price of gold rather than Moody's. Erik Schatzker deadpans: "Okay so the problem of course is that the U.S. government doesn't borrow in gold, it borrows in Treasury bonds."