Monday, 14 January 2013

The Politics of Ratings, and the Politics of Avoiding Ratings

A while back I wrote a post about the muddling of finance and politics. The Eurozone crisis had seen France stripped of its AAA rating, and the move hadn't been taken well in France or the rest of the Eurozone. In particular, there was a significant, and very public, "answer back" from the French government and central bank, claiming that the UK should be downgraded first. 

These downgrades, along with those of Italy and Greece, had been notable for the significant political rhetoric behind the ratings. As was plainly cited at the time, the lack of political leadership and consensus was one of the main factors behind the downgrades, making the CRAs political commentators as well as risk assessors. This has never been denied by the CRAs. In their sovereign rating methodologies, each of the Big Three provide for political risk factors to be included in the assessment, along with "other factors" that the analyst might deem relevant. (Standard & Poor's sovereign rating methodology can be found here, and Moody's methodology is here. Interestingly, Moody's is currently seeking feedback to proposed "refinements" of its sovereign rating methodology. More on this in a later post).

The problem now, though, is that the US is facing the same. The fiscal cliff negotiations that played out in the final minutes of 2012 displayed to the world how divided the US legislature really is when it comes to solving the fiscal problems facing the US. Maybe "problems" is an understatement? 

In August 2011, Standard & Poor's downgraded the US one notch from AAA to AA+. This was the first downgrade in US history and stunned Washington. S&P cited - unsurprisingly - the large debt burden, but also the political stalemate that made tough decisions to tackle the deficit nigh on impossible. It seems that Moody's and Fitch, however, are looking very closely at their top ratings in the US. Fitch, speaking during the negotiations, reminded us that failure to raise the debt ceiling would exacerbate uncertainty over US fiscal policy and send the US into an unnecessary recession. It stated that this could erode medium-term growth potential and financial stability, leading to an increased likelihood that the US would lose its AAA status. Moody's, taking a similar line, has also expressed concern about the lack of political consensus to come up with a credible long term debt reduction plan. It stated that the current AAA rating will only be confirmed if current negotiations lead to a long term strategy that reduces debt to GDP ratio. 

The political aspect of downgrades of Berlusconi's Italy centred on the lack of credibility of the leader. But in the US, the political agenda is not the issue, so much as the lack of ability to reach a suitable agreement. Politics may not be the issue, but it got in the way of finding a solution to the real, underlying problem. The fiscal cliff may have been avoided, but the issues surrounding debt levels remain. It is estimated that without action, the US debt will reach $25 trillion by 2022. Moody's statement that only a reduction in the deficit will lower the likelihood of a downgrade seems rather trite considering the figures. For now, the country remains on "negative outlook".

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