What's happening at the
Sunday 20 Aug 2017 | 07:08 | SYDNEY
Sunday 20 Aug 2017 | 07:08 | SYDNEY

Credit rating agencies: A dismal story



21 April 2011 11:07

Standard and Poor's (S&P) has just put the US on notice that there is a one-chance-in- three that they will lose their AAA rating.

In earlier blogs, I have wondered why anyone takes any notice of credit rating agencies, given their pitiful (and very damaging) performance in assessing risk in the lead-up to the global financial crisis, and more recently their inexcusable tardiness in recognising the problems in the European peripheral countries.

Still, they seemed to have moved financial markets this time. Equity prices around the world fell sharply in response to the S&P announcement. You might have thought that S&P's concerns about US debt might have lowered the price of US bonds (and thus raised the yield). But no: bond yields have fallen.

Financial market economists can always find an ex-post explanation for whatever happened, even when they predicted the opposite. In this case, the market apparently believes that the S&P warning will break the political deadlock and the US budget problems will now be solved. The 'bond vigilantes' have appeared on the scene and their very presence will be enough to return the US to the path of fiscal virtue.

But why then, did equity prices fall? You might think that as investors shifted out of bonds, equity prices would have gone up. Again, market economists have the answer: fixing the budget means raising company tax, which is bad for share prices. The fact that no-one is talking about company tax increases has to be ignored.

Another possible explanation is that the S&P announcement told the market nothing that it didn't already know and that it was ignored by that part of the financial market most closely involved: the bond market. Equity prices went down because this is a flighty market which startles at any news, no matter how trivial or irrelevant (and it has since regained its composure).

Of course we have some longer-term experience on the irrelevance of credit ratings. Japan was down-graded from its AAA rating in 2002 and has recently been downgraded even further. Through all this, the Japanese bond markets have taken no notice.

This is the one hope in an otherwise dismal story: that over time the credit rating agencies, with their rear-view mirror of what is happening, will become totally irrelevant.

Photo by Flickr user pamhule.

You may also be interested in...