UK and USA might lose AAA rating

May 26, 2009 3:11 PM

Standard & Poor’s changed the UK's credit outlook from stable to negative a few days ago, and warned that there is a chance the UK could lose its AAA rating. Meanwhile, Moodys, another of the big 3 rating agencies, has warned that the US might also eventually lose its AAA rating. The UK announcement caused sterling to drop by 1% and the FTSE by 2%. However, many blame the same rating agencies for their part in triggering the subprime crisis. The irony of this is not lost on the Wall Street Journal, who note that "After all, those governments are jacking up spending, in part, to bail out the financial firms who gobbled up those 'AAA' asset backed securities duly blessed by the credit ratings firms."

How did the CDO's get AAA rated in the first place? There are reports that it may have been a bug in the rating software, although Greenspan says its because the ratings were based on only the last two decades, giving a too-optimistic outlook. This reseach paper by Vasiliki Skreta and Laura Veldkamp looks through some of the options.

Incidentally, all the ratings given by the rating agencies come with a disclaimer: S&P says in small print: "Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision". Joseph Mason, a former economist at the US Treasury Department, points out that "The ratings giveth and the disclaimer takes it away."

posted by memebake (38 comments total)

I wonder how many of us think it's hilarious that lots of financial institutions around the world are run by people who can't manage their personal funds.
posted by kldickson at 3:14 PM on May 26, 2009 [1 favorite]

Fox proxy certifies henhouse as unsafe : suggests less money be given to guards.
posted by lalochezia at 3:16 PM on May 26, 2009 [6 favorites]

There's a bit of a lynching spirit in the UK at the moment, mainly directed at politicians, but I wouldn't be suprised to see a few bankers hanging from lamp-posts once it all goes tits up.
posted by Artw at 3:22 PM on May 26, 2009

...mainly directed at politicians, but I wouldn't be suprised to see a few bankers...

Line 'em up. It's a big wall.
posted by rokusan at 3:26 PM on May 26, 2009

I question how much value a AAA credit rating really is, anyway, especially during this GFC. Seems to me that if a country or a state goes to AA or A, it's no big deal, especially if said country or state is spending/borrowing all the extra money on infrastructure projects and other initiatives that will see people keep their jobs or create new ones.

Sure it means extra interest on borrowed money for the Government but right now keeping a AA credit rating seems less important than creating new jobs (preferably through infrastructure projects that will help the economy recover quickly when the GFC ends) and making sure we help people keep the jobs they have as best we can through stimulus packages and other spending measures.
posted by Effigy2000 at 3:45 PM on May 26, 2009 [1 favorite]

The US has been in danger of losing its AAA rating every 6 weeks for as long as I can remember.

How is this time different again? Oh the journalist involved feels that it's about to happen. Yep. That seems like a dead on certainty to me.

As much as it pains me to admit this, the US gets a free ride on this one. Losing the AAA rating is a semi-empty threat. If the US was to lose its AAA rating where would the billions in treasuries that would be pulled out by pension funds, sovereign funds and other funds that typically only accept AAA securities go? Other AAA securities? There isn't enough to go around to soak up all of the money that would be flooded onto the market.

If a CDS is a financial WMD then the US losing its AAA rating would be the Tsar Bomba. The US government's credit lines would seize up, they'd have to print dollars instead of borrowing them inflating the currency and everyone would lose.

While petrodollars exist and the US dollar remains a de facto reserve currency nobody wants to see the AAA rating being removed from US treasuries. The financial collateral damage it would cause, even as a symbolic gesture, would make the liquidity crisis look like a Sunday picnic.
posted by Talez at 3:52 PM on May 26, 2009 [5 favorites]

Well said, Effigy.
posted by honest knave at 3:53 PM on May 26, 2009

I question how much value a AAA credit rating really is, anyway, especially during this GFC.

If the US loses its AAA credit rating it loses access to hundreds of billions of dollars in AAA only investment funds that typically get dumped in treasuries. Hell, it's written in law that US pension funds can't go any lower than AAA funds so you'd lose all those automatically.

You'd be gambling that there's enough capital available at the AA levels of the bond market to finance the US government's obligations. There probably isn't.
posted by Talez at 4:00 PM on May 26, 2009 [1 favorite]

Potemkin ecomomy.
posted by telstar at 4:07 PM on May 26, 2009

Also, if the US goes AA then yields presumably go through the roof, and interest rates follow, while the dollar falls. High interest rates accompanied by high inflation will, as Talez says, make the current crisis look like a picnic.

Exercise for the reader: what would your mortgage payment look like if interest rates were 15%? Or 25%? If you rent, you can assume your rents will rise accordingly.
posted by unSane at 4:10 PM on May 26, 2009

And also, most of the primary dealers and foreign national banks are stuck VERY long on long-term treasuries at the moment. They are already suffering a so-called 'long squeeze'. The Fed is doing all it can to keep the prices up but it's basically the only buyer. The consequences of a sharp rise in yields on the long end of the curve would be the destruction of a huge amount of capital.
posted by unSane at 4:14 PM on May 26, 2009

Exercise for the reader: what would your mortgage payment look like if interest rates were 15%? Or 25%?

I'll ask my parents. Their mortgage was about ~20% when I was a kid. I remember having all those 13% interest Canada Savings Bonds and it seemed pretty awesome at the time.
posted by GuyZero at 4:16 PM on May 26, 2009

But do the rating agencies still have any credibility?
posted by memebake at 4:18 PM on May 26, 2009

It doesn't matter if you have credibility when your function is written into law.
posted by Talez at 4:40 PM on May 26, 2009

The government won't let the ratings agencies drop the US credit rating. They'll drag executives in and have them waterboarded (or worse, use the IRS) before that, for exactly the reasons Talez points out.

What will happen is that the US government will always stay "AAA", but everyone will know that it's a lie and the ratings agencies are being about as honest as a hostage making a televised statement while a gunman waits just off camera. They will lose credibility, or at least that particular rating will lose credibility.

Maybe the agencies will find some weasely way to say that they don't think that the USG should be AAA anymore, without actually saying it. I'm sure one of those Harvard grads can think of a clever way to do it. Maybe just toss in a footnote or something.

My suspicion is that the result would be sophisticated investors running for the lifeboats, while pension funds and other investment vehicles set up for the hoi polloi go down with the dollar.
posted by Kadin2048 at 5:00 PM on May 26, 2009 [1 favorite]

Talez: It doesn't matter if you have credibility when your function is written into law.

Yikes

So, these rating agencies are profit-making businesses, apparently accountable to no-one in particular, with a history of questionable rating decisions (Enron, CDOs), and laws exist that are based around the ratings they give out. Or have I missed something?
posted by memebake at 5:08 PM on May 26, 2009

I can't think bonds without thinking "Christmas Ted, what does that mean to you? It was living hell. Do you know what its like falling in the mud and getting kicked, in the head. With an iron boot? Of course you don't, no one does, that never happens. Sorry Ted, that's a dumb question."

Reading the article though, now I'm thinking it looks like I picked the wrong week to quit sniffing
glue.
posted by Smedleyman at 5:16 PM on May 26, 2009

I was wondering whether something like this would happen when Berkshire Hathaway lost its AAA rating. Berkshire is a conglomerate of a lot of successful, stable US companies, so if they're down, I figure it's the case for the whole US economy.
posted by zippy at 5:42 PM on May 26, 2009

The ratings remain AAA, due to support by the same institution they are certifying. Sounds like "good ol' Communism" to me.
posted by sporb at 5:49 PM on May 26, 2009

What will happen is that the US government will always stay "AAA", but everyone will know that it's a lie and the ratings agencies are being about as honest as a hostage making a televised statement while a gunman waits just off camera. They will lose credibility, or at least that particular rating will lose credibility.

Yes and no. What's the saying? When you owe the bank 100 grand you have a problem, when you owe the bank 100 billion the bank has a problem?

The current situation is like trying to juggle a bunch of chainsaws while standing on top of a beach ball but it works. We look at 10 trillion dollars as an absolutely stupifying number to pay but it's still only 60ish percent of GDP. Despite the number of people on main street that will scoff at this statement, it's a sustainable level of debt for the moment compared to other G20 countries.

One thing's for sure though. The US needs to get back to producing stuff. The only thing that will save the US manufacturing sector and the US economy in the long run will be a wholesale shift in certain costs from employers back to the public at large (in the form of government services). Health, unemployment, pensions. These are all costs borne by taxpayers in other countries. Want to know why GM has to pay a UAW worker "$70/hour"? There's your answer. Half of it goes in pensions and health care.

Jack up your tax rates if need be, start converting over to single payer health care sector by sector. Mandate mandatory 401(k) contributions by employers and phase them in over the next 8-10 years.

At this point you don't need single payer health care and proper self-funded social security to give people a safety net. You need it to save your economy full stop.
posted by Talez at 6:10 PM on May 26, 2009 [2 favorites]

"Maybe the agencies will find some weasely way to say that they don't think that the USG should be AAA anymore, without actually saying it. I'm sure one of those Harvard grads can think of a clever way to do it. Maybe just toss in a footnote or something."

This is easy, they just bring out a higher rating. Diamonds or stars or something.
posted by Mitheral at 6:13 PM on May 26, 2009 [1 favorite]

The ratings remain AAA, due to support by the same institution they are certifying. Sounds like "good ol' Communism" to me.

Well, to be fair, the private institutions whose crap bonds had been getting AAA ratings all that time were also supporting those same rating agencies, and for years, that's been considered "good ol' Capitalism."

The rating agencies, see, have always been paid directly by the entities they rate.
posted by saulgoodman at 6:19 PM on May 26, 2009

This is easy, they just bring out a higher rating. Diamonds or stars or something.

America is now restricted to Platinum Executive class customers only. To inquire about upgrading your American Citizen Plan, please contact one of our regional offices.
posted by The Whelk at 6:49 PM on May 26, 2009 [1 favorite]

Mitheral is right, next stop will be the introduction of AAAA rated bonds.
posted by bystander at 7:10 PM on May 26, 2009

Predicted here, about two hours ago.

Uh oh, we're finished.
posted by webhund at 7:38 PM on May 26, 2009

"Maybe the agencies will find some weasely way to say that they don't think that the USG should be AAA anymore, without actually saying it. I'm sure one of those Harvard grads can think of a clever way to do it. Maybe just toss in a footnote or something."

Grade inflation? AAA+!
posted by Blazecock Pileon at 9:32 PM on May 26, 2009

For the ultra-rich, there's seven diamond securities: high-end financial products that provide the full functioning-economy experience.
posted by You Can't Tip a Buick at 9:59 PM on May 26, 2009

One thing's for sure though. The US needs to get back to producing stuff. The only thing that will save the US manufacturing sector and the US economy in the long run will be a wholesale shift in certain costs from employers back to the public at large (in the form of government services). Health, unemployment, pensions. These are all costs borne by taxpayers in other countries. Want to know why GM has to pay a UAW worker "$70/hour"? There's your answer. Half of it goes in pensions and health care.

The fact that we have such an out of control medical system means that no one has been able to do any kind of cost control, insurance companies make money by avoiding providing insurance to sick people and weaseling out of paying claims on people they do insure. If you look at other countries they've been able to do a lot to keep costs down. There are a lot of things you can do globally to reduce cost that wouldn't damage quality of care. For example, if a medical company comes up with a new test, they have no reason to try to lower the cost. Quite the opposite, they want it to be as expensive as possible. On the other hand, if the government was doing the research, they'd obviously want to continue doing R&D to lower the costs even more.

As far as producing stuff, we produce plenty of stuff, the question is: how much stuff do we need? I mean the idea that we should run around "making stuff" for the sake of it is kind of strange. There needs to be demand as well as production capability. And we do make tons of stuff already, but it's mostly done by machine. The dolor value of our manufacturing today is higher then it was in the 1970s (even adjusted for inflation), but fewer people are employed because the labor efficiency is so much higher.
posted by delmoi at 10:19 PM on May 26, 2009 [1 favorite]

The dolor value of our manufacturing today is higher then it was in the 1970s (even adjusted for inflation), but fewer people are employed because the labor efficiency is so much higher.

While the dollar value may be higher are you so sure that it comes through labor efficiency? Look at a company like Intel for example. Completely overseas manufacturing. $37.6b in revenue, $9b profit last year. Almost all of the manufacturing for the actual processors is done overseas. Does that full amount get counted in that dollar value of US manufacturing? Because it doesn't seem like it should and it seems like it is with these statistics.

There's no doubt that US companies are extremely good at farming out manufacturing work to other countries and then taking the credit. But does that help the manufacturing workers in the US? Not really.

It's not that I don't believe you that US manufacturing is more efficient. It may be but it's really a moot point. But I get the feeling that if the US had a successful home grown manufacturing sector exporting to the world they wouldn't have a trade deficit getting perilously close to $1 trillion/year. To be blunt, the numbers don't add up.
posted by Talez at 10:42 PM on May 26, 2009

AAA+++ GREAT COUNTRY WILL BUY AGAIN!
posted by DreamerFi at 10:56 PM on May 26, 2009 [5 favorites]

The government won't let the ratings agencies drop the US credit rating. They'll drag executives in and have them waterboarded (or worse, use the IRS) before that, for exactly the reasons Talez points out.

That explains why the big ratings agencies have been so timid about the credit ratings of the US and the UK, even though they've been aggressively cutting those of other countries, including euro-area countries whose public accounts, while struck by the crisis, aren't nearly as creaky as those of the US and UK. It particularly irks me that S&P has lowered Spain's credit rating from triple-A to AA+, even though, on every single metric you can think of (public debt, deficit...) Spain's public accounts are considerably healthier (or at least less sickly) than Britain's.

The Economist has an article this week about the emergence of ratings agencies based in emerging countries, and in particular about a Brazilian rating agency which has had the effrontery to rate US government bonds as AA. So, maybe the now-infamous invisible hand of the market will correct the blatant inbreeding of the credit rating system after all...
posted by Skeptic at 4:08 AM on May 27, 2009

That same article includes a statement that doing so (rating the US @ AA) is a knowingly provocative act. Exactly the sort of quality decision making we've come to expect from the ratings agencies.

The real answer to all this is ban ratings. Force people to do due diligence themselves. Would have prevented this entire crisis.

The idea of a country defaulting (and that's what the ratings are - default probability ratings) that has all of its debt denominated in a currency it can choose to debase is laughable. This is why the UK is rated above Spain. If the UK runs out of pounds it prints more. If Spain runs out of Euros it either begs the Germans to help or it defaults.
posted by JPD at 5:25 AM on May 27, 2009

Look at a company like Intel for example. Completely overseas manufacturing.

Statements as wildly inaccurate as that undermine whatever point you wanted to make.

Intel has several wafer fabs in the US, one in Ireland, and two in Israel. In particular your statement will come as a surprise to the people working at Fab 11X in New Mexico, Fab 32 in Arizona, and Fab D1D in Oregon who thought they were in the highest-level 45nm plants. It will also surprise them in that they had previously read that Intel would be upgrading their fabs to 32nm Core i7 production.

Intel chips all say "made in Malaysia" or any of several other Asian countries because that's where they cut the chips from the wafers and put them in cases. Can you guess which of the activities -- turning raw silicon into completed wafers, or cutting wafers up and putting them in chip cases -- is the high value added part of the equation?
posted by ROU_Xenophobe at 6:42 AM on May 27, 2009 [4 favorites]

The book Fiasco by Frank Partnoy has some excellent insight into the manipulation of credit ratings. Portnoy worked in derivatives at an investment bank in the 1990s and describes mind-boggling layering of holding companies in different countries to mask the country of origin of the original bonds, so that a top credit rating could be obtained for the risky derivative product, which would in turn be sold off to clueless "widows and orphans." I reckon the shenanigans going on ten or more years later are even more outrageous.
posted by exogenous at 7:33 AM on May 27, 2009 [1 favorite]

So what can I do to take advantage of this situation?
posted by pakoothefakoo at 7:51 AM on May 27, 2009 [1 favorite]

In fairness, Intel is probably the lone example of domestic US semiconductor manufacturing. Memory is made in Korea, Japan, Germany, etc but not in the US. A lot of non-Intel processors are manufactured completely overseas. Taiwan has a near monopoly on supporting chipsets. I suppose that it's a pretty level playing field globally across all forms of VLSI but the US could have a lot more of it if they got their act together.
posted by GuyZero at 9:11 AM on May 27, 2009

It is so obvious that the community spread of this crisis -- and outside of North America in 2 or more non-rating-agency regions, no less -- DEMANDS that they raise the level to 6. Why haven't they done so yet?

Oh...wait. This isn't the swine flu thread?

Sorry, carry on. I'm sure those other, non-health related agencies you're talking about here are doing a fantastic job of accurately reflecting reality.
posted by staggering termagant at 1:08 PM on May 27, 2009

If the UK runs out of pounds it prints more.

Except that the people in charge of printing those pounds aren't the HM Treasury but the Bank of England. And, theoretically, the Bank of England is just as independent from HM Treasury as the European Central Bank is from the Spanish Ministry of Finance. (I know, I know, and you may have bridge to sell me if I believe that...)
posted by Skeptic at 1:52 PM on May 27, 2009