S&P Ratings - The aftermath

I am not an economist. 


I know there are basic principles - supply and demand, etc. I more or less have some grasp of the way the system works (at least, I've thought about it). But anything below the surface? Well... let's just say at one point I decided to crack a text book to try to learn on my own, and I glazed over in the first few pages. Thrilling it was not.


Now I kind of regret not taking econ classes, because I feel continuously in a state of catch-up.


Take the stock downgrade by Standard & Poor's, for example, on August 5. It's all over the news, and it's hard for me to really evaluate the stories/analysis without taking the reporter/oped at it's word.


From my disclaimer above, I've obviously got a long way to go before I can do anything other than repeat opinions of "what to do." And I'm not going to even touch the "why" - HCR stated it pretty nicely a few weeks ago. 


So what's gotten my attention so far? The purpose of agencies like the S&P, and the response since the downgrade.


S&P is an American financial services company that offers credit ratings (Moody's and Fitch are the other two major ratings agencies). Clients (countries, municipalities, companies, etc) pay the S&P to rate their bonds, which in turn communicates to investors the risk associated with that investment. 

From the S&P "General Criteria: Understanding Standard & Poor's Rating Definitions." June 3, 2009.

Ratings convey the "creditworthiness" of the investment - that is, the likelihood that debts will be paid back according to the terms of a contract. The possibility of default is the key factor that issues S&P ratings, according to their site, although other factors play a role in rating. 

In our view, likelihood of default is the centerpiece of creditworthiness. That means likelihood of default--encompassing both capacity and willingness to pay--is the single most important factor in our assessment of the creditworthiness of an issuer or an obligation. Therefore, consistent with our goal of achieving a rank ordering of creditworthiness, higher ratings on issuers and obligations reflect our expectation that the rated issuer or obligation should default less frequently than issuers and obligations with lower ratings, all other things being equal.

Although we emphasize the rank ordering of default likelihood, we do not view the rating categories solely in relative terms. We associate each successively higher rating category with the ability to withstand successively more stressful economic environments, which we view as less likely to occur. We associate issuers and obligations rated in the highest categories with the ability to withstand extreme or severe stress in absolute terms without defaulting. Conversely, we associate issuers and obligations rated in lower categories with vulnerability to mild or modest stress.

--From the S&P "General Criteria: Understanding Standard & Poor's Rating Definitions." June 3, 2009. (emphasis mine)

Just reading this excerpt - dated from 2009 - puts the S&P's decision to downgrade the US debt in less questionable ground (at least, in my mind). It also throws interesting light on the posturing that's gone on in the wake of the debt deal - in some cases, posturing that could further jeopardize the credit rating were it to become reality, like Perry & Romney's statements against the debt deal. Failure to come to a compromise seemed to be central to the S&P evaluation. 


As for that difference in bond ratings...? 

From the S&P "General Criteria: Understanding Standard & Poor's Rating Definitions." June 3, 2009.

The US now shares a credit rating with Spain, which has been downgraded as part of the fallout from Greece's repeated economic woes in the European debt crisis (Greece has been downgraded to junk status).


To get further perspective, here's a list of credit ratings of countries worldwide.


Amid all the finger-pointing and railing in the wake of the downgrade are a few stories that have gotten my attention.


First, the Obama adminstration's reaction to the "miscalculation" in the S&P analysis. Legitimate? Yes. But it simply made the S&P come out and fully explain the political nature of its decision.


Three downgraded municipalities have "fired" the S&P. 


Allegations have arisen (or been implied) of "insider trading" at the S&P in advance of the downgrade.


There is an ongoing investigation as to whether or not the S&P improperly rated mortgage securities in advance of the debt crisis.


I'm interested to see how this plays out. The last one is particularly interesting. Is it possible that the S&P "caused" the debt crisis (or is this an argument that is being shored up for use against the S&P in the future, possibly to mitigate any fallout from the downgrade)? 


Is the S&P the cause of the recession (or will it be the cause of a relapse), or is the downgrade an effect of the recession? It seems very circular to me.


Has the dust-up damaged the reputation of the S&P? How will this affect the benefits of good credit ratings from this agency? 


How will the decision to drop the S&P by Los Angeles and two counties in California affect those municipalities - both in terms of future investiment, and in economic recovery? To me, it doesn't seem legitimate to drop a credit agency because they call you out as an investment risk. 


Finally, I know the news has said the mortgage probe began before the downgrade, but I can't help but feel there might be political motivations on either side. Should S&P have to consider political fallout in the wake of its decisions? If there's evidence of this (or the perception of it), how will it affect the legitimacy of S&P credit ratings?




These are just the questions rattling around in my head. What do you think?