S and P: Not the Best Judge of Credit-Worthiness

The media and the talking heads will no doubt make a big deal about S&P downgrading the U.S. debt from AAA to AA and threatening to go to A in 6 months.  But it’s really nonsense. The U.S. it is not possible for a sovereign nation with it’s own currency, it’s own central bank, and that borrows in that same currency to go into default.  I just heard Faux Fox News say this afternoon that this will cause all of us to pay higher interest rates on home mortgages and car loans!  Honestly, where do they get these people?  Fox claimed that your car loan and mortgage are “pegged” to the 10 year government bond rate.  Nope.  Not true.

Anyway, what we should be doing is taking another look at this whole bond-ratings scam.  Standard & Poor’s basically has a business model where they rate bond issues in return for fees paid by the banks selling those bonds.  There’s no reason or need for them to rate government issues except maybe for obscure municipal bonds where the information for an informed decision isn’t easy to come by.

So let’s recap how S&P has done in the past.  My favorite two highlights are Japan and Lehman Brothers.  In Japan, this is how interest rates (yields) on 10 year Japanese bonds have behaved since Jan. 2000:

It was in January 2001, right about when the yield hit it’s peak of 2.0% that S&P downgraded Japanese 10 year bonds indicating S&P thought the bonds were riskier and should pay an interest rate premium.  Kind of looks like Mr. Market and Ms. Investors didn’t agree.  Not having learned their lesson on the economics of sovereign debt, S&P did it again in January  2011 with another downgrade.  I think S&P needs to throw out their models and go back to school.

Now let’s look at the other side.  In September 2008, the day before Lehman Brothers filed for bankruptcy, S&P rated them “A”.  Two weeks later, even though Lehman had already gone bankrupt, S&P still didn’t get it and defended their rating:

“In our view, Lehman had a strong franchise across its core investment banking, trading, and investment management business,” S&P stated. “It had adequate liquidity relative to reasonably severe and foreseeable temporary stresses.”

Source: CFO Magazine