Why Does Anyone Listen to S&P?

S&PFor decades, I’ve wondered just why we have credit ratings agencies. They clearly aren’t good at their jobs. There is no real reason that we should listen to them. There is a real chicken and egg aspect of it. We seem to invest confidence in them because we invest confidence in them. Of course, over the last decade it has been so much worse. First, they all gave AAA ratings to garbage mortgage backed securities. After the financial crisis showed them for the useless institutions they are, they all sat in front of Congress saying that it wasn’t their fault; they were just expressing an opinion. Fair enough. But then everyone went back to pretending that they actually knew something and weren’t just exercising their First Amendment right to talk out their asses.

The second big event was in August 2011, when S&P downgraded the US federal government’s credit rating. It was a funny thing, because at first it was based on some bad math by S&P. When the government pointed out the error, S&P decided to downgrade the credit rating anyway. It showed that the downgrade wasn’t about reality so much as S&P sending some kind of a message to the world. But here’s the funny thing about that downgrade: it didn’t seem to change the cost of borrowing for the US — at all. It is as though bond buyers — who have actual money on the line — knew that S&P was full of shit.

Well, as you may have heard, last week, S&P downgraded France. Paul Krugman wrote an excellent article about this on Friday. He argues quite convincingly that the issue here is not economics at all, but rather politics. Looking at France’s economy, all he sees is that it is doing rather well — better than countries that have a AAA credit rating with S&P. In fact, France has also brought down its deficit. The problem, for the standpoint of S&P and others, is that France didn’t do it the right way:

Two months ago Olli Rehn, Europe’s commissioner for economic and monetary affairs — and one of the prime movers behind harsh austerity policies — dismissed France’s seemingly exemplary fiscal policy. Why? Because it was based on tax increases rather than spending cuts — and tax hikes, he declared, would “destroy growth and handicap the creation of jobs.”

In other words, never mind what I said about fiscal discipline, you’re supposed to be dismantling the safety net.

He even quotes the S&P justification and, although it is written in finance jargon, it says the same thing. Not that it matters. Again bondholders don’t seem to care. The French government can borrow at pretty much the same rate as they could before.

But I have a broader question. All the credit ratings agencies seems to be useless. S&P in particular seems to have some kind of conservative ax to grind in addition to being useless. Actual buyers of bonds indicate that they know the credit ratings agencies are useless. So why do we still grant them any respect? Why do we allow banks to use them to justify their actions? And most of all, and to the point, why is a ratings change from S&P given any more credence than an RNC announcement?

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About Frank Moraes

Frank Moraes is a freelance writer and editor online and in print. He is educated as a scientist with a PhD in Atmospheric Physics. He has worked in climate science, remote sensing, throughout the computer industry, and as a college physics instructor. Find out more at About Frank Moraes.

2 thoughts on “Why Does Anyone Listen to S&P?

  1. I suppose the ratings agencies are like the cute employees standing by the roulette wheel. The serious gamblers aren’t fooled by a smile and a hint of cleavage. But the casino would really like it if you came over and said "hi."

  2. @JMF – I didn’t get into it (I thought about it), but a big issue is that the ratings agencies are run by "the right kind of people." It’s the same reason that Tagg Romney is a successful investment banker.

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