The U.S. government has heavily criticized Standard & Poor’s for downgrading the U.S. credit rating, claiming flawed analysis. But such faulty data has been something that AFP members have recognized for years. Even before the financial crisis of 2008-09 and especially after, there were many corporates that questioned just how much the market should be relying on the credit rating agencies.
Since the financial crisis and the negative attention that the rating agencies received, they have become increasingly hesitant to deal out AAA ratings, said D. Anthony Scaglione, CTP, Vice President & Treasurer at ABM Industries Inc. and a member of AFP’s Board of Directors. “The pendulum has swung pretty dramatically,” he said. “Pre-crisis, the rating agencies were much more amicable to granting ratings on a best-case scenario. Now, post crisis, they’re much more apprehensive in terms of granting initial ratings and they almost take an ‘at worst’ perspective and try to move up from there.”
There were many in the industry that questioned the legitimacy of the Nationally Recognized Statistical Rating Organizations (NRSRO) even before the financial crisis, such as during the Enron scandal of 2001. In 2002 and 2004, AFP conducted surveys with senior-level financial professionals regarding the reliability of the rating agencies. In both instances, many respondents said that the NRSROs’ ratings were neither accurate, nor timely.
“Our members have told us for years that the credit ratings are neither reliable, nor accurate,” said Jeff Glenzer, CTP, Managing Director at AFP. “We have surveys on that going back to 2002. So it’s really not surprising that when S&P downgraded the U.S. government that our members, based on the survey we did recently, really didn’t dramatically change their holdings. Our members aren’t big believers in the quality of what the rating agencies put out.”
But despite how little credibility rating agencies might have, debt issuers realistically have no choice but to use the ratings, Glenzer added. “It’s just the way that the capital markets work; if they want to issue debt, they need those ratings,” he said.
While critics have cited renewals of AAA ratings by Moody’s and Fitch as proof that the U.S. downgrade by S&P was unwarranted, Glenzer argued that there really is no point in having multiple ratings agencies if they are all going to provide the same rating. Moreover, he pointed out that a smaller agency, Egan-Jones, actually downgraded the U.S. several weeks prior to the S&P downgrade.
Scaglione noted that while S&P undoubtedly put a lot of time and thought into its decision to downgrade to the U.S. credit rating, there really has not been any major market reaction and thus it might simply be the result of S&P being overly cautious. “Hindsight being 20/20, I’m not sure that they would come to the same conclusion with the additional information,” he said. “Fitch came out this week, reaffirming the U.S. AAA rating. I think the market reaction to the downgrade was a non-event. So what did it actually do, other than create a lot of headline noise and a lot of analyst economic reports? It didn’t really change the risk profile of the U.S. government, at least in the interim.”
A major debate that has come to light in the wake of the downgrade is whether or not the credit rating agencies, for economic purposes, will again bend to pressure to raise ratings. “The government that was criticizing the rating agencies for bowing to pressure is now calling the one agency that downgraded them before Congress to put them through a very serious inquiry,” said Glenzer. “That is, in some ways, probably the ultimate form of issuer pressure that could be brought to bear.”
After the financial crisis, we saw a push for more regulations on ratings agencies. AFP initially advocated for better regulation and managing conflicts of interest. This eventually evolved into a push for the elimination of conflicts of interest by coming up with different compensation models for the ratings agencies. However, applying such a method could prove to be a long and complicated process.
“What’s interesting to me about this and how it specifically relates to sovereign debt is that the government built its own gallows,” said Glenzer. “And then the recent debate about the debt ceiling was really sharpening the blade on those gallows because they empowered the ratings agencies to the point that this type of thing could happen. The rating agencies were originally nothing more than publishers of opinions and they will argue that that’s still what they are.
“The problem was that the government, in the 1970s, outsourced its responsibility for assessing capital adequacy in banks to the rating agencies. They bestowed a lot of power onto them. So it’s a little hard for me to have sympathy for the government, because if the ratings agencies are just publishers of opinions, is that the basis on which you want to regulate banks and broker dealers? If you think you can do it better, then maybe you should be doing it instead of continuing to outsource it.”
Scaglione believes that the role that the rating agencies play for the economy is important, but he acknowledged that it has gradually become harder to trust them. “It’s a little bit confusing to an investor or a corporate manager when there are disparate reports out there from two reputable rating agencies. Who do you place reliance on? But I think the U.S. downgrade, and the information that came out that [S&P] had a $2 trillion error in their calculation, and then Fitch’s confirmation of the U.S. credit rating, just creates a lot of additional confusion and noise in the marketplace.”
For more information, please review the 2009 statement of Jim Kaitz, President and CEO of AFP, at the U.S. Securities and Exchange Commission Roundtable to Examine Oversight of Credit Rating Agencies: