‘We rate every deal. It could be structured by cows and we would rate it’.
THAT email, from one employee of Standard & Poor’s to another, emerged in evidence before a US congressional committee during the height of the financial crisis in 2008. It was October 22, the sharemarket was in free fall as irate politicians took the ratings agencies to task.
Putting aside for a moment this egregious insult to cows – which are gentle animals not given to greed and irrationality like ratings agencies – Moody’s Investors Service came out yesterday and solemnly confirmed its Aaa credit rating for the US. As if it mattered.
This came hard on the heels of another agency, Fitch, also upholding its AAA rating. The third, S&P, has foreshadowed an adjustment to its rating and now that a debt deal has been hammered out on Capitol Hill will no doubt sally forth soon.
The question is: why should anyone care?
”The story of the credit rating agencies is a story of colossal failure,” said committee chairman Henry Waxman, a California Democrat back in October 2008. ”The result is that our entire financial system is now at risk.”
Former executives from S&P and Moody’s also gave evidence. They told the hearing that their former employers had engaged in a ”race to the bottom” to maximise their profits.
It used to be that only the cream of sovereign states and a handful of big blue-chip banks attracted AAA ratings. During the boom years, though, the agencies began to sell AAA ratings to investment bankers for their financial products: even the likes of collateralised debt obligations (CDOs), whose underlying securities were often low-grade, high-risk debts.
This untenable conflict of interest – that is, that the agencies get paid per rating – has not changed. Neither has their propensity for getting to the murder scene after the body has been whisked away.
Credit rating agencies are always reactive, rather than proactive, issuing a press release and a statement of the obvious well after the market has made its judgment and priced in a new reality.
What has changed is the trust in the system. It is eroding. Trust in credit ratings, trust in banks and financial institutions – which have been bailed out and enfeebled by ”moral hazard” – trust in government to resolve the likes of the debt crisis and manage the economy and, most recently, trust in government statistics.
As if the muddling over the debt ceiling weren’t enough to unnerve markets, the Bureau of Economic Analysis – the US equivalent of the Australian Bureau of Statistics – belatedly revealed last week that the US economy had actually contracted by 5.1 per cent during the financial crisis, rather than 4.6 per cent. The revisions had everyone wondering what else they had wrong and how long it might take to find out.
According to CNN’s ”bailout tracker”, the government has committed $US11 trillion ($A10.1 trillion) and spent $US3 trillion on programs to rescue the US economy. We’re talking TARP, the Federal Reserve’s stimulus efforts, the AIG bailout, assorted bank takeovers and other financial and housing initiatives. The Fed is the biggest spend.
And, incidentally, as the Fed’s balance sheet has ballooned from a pre-crisis $US900 billion to $US2.85 trillion, those CNN numbers look a tad light – even though $US120 billion of the TARP money has been repaid.
All up we have a situation where Main Street has spent trillions bailing out Wall Street and propping up the economy. Yet, only two years out from the meltdown, at a time when economists had all predicted the world would be in robust recovery, America is sliding towards recession again.
Meanwhile, the debt-ceiling debacle has coincided with the end of the Fed’s stimulus. Until June, America had been merrily buying its own bonds, printing money and funding its own debt via ”quantitative easing” programs. This had been propping up Wall Street.
Going cold turkey on stimulus at a time when the economic statistics have just turned south … It’s not going to last. QE, in some form, will start again soon – even as Washington has just gone to the brink of defaulting on its gargantuan debt.
Against the backdrop of soaring deficits, desperate stimulus, diminishing growth and declining confidence in the system – bear in mind that capitalism is utterly reliant on trust; trust that a counter-party can and will honour an obligation – we have the ratings agencies confirming the US as a AAA proposition.
This sort of thing can only lend credence to the Tea Party types who reckon they should have let the whole thing blow up and rebuild from the ashes.