Triple

30th November 2011

Common sense suggests that this cannot continue, even if George Osborne has staked his reputation on retaining this status. Britain will become the most indebted country with a triple-A credit rating on the international money markets, according to ratings agency Fitch.

 

But what is the meaning of such a status in troubled times?

The big three agencies, Fitch, Moody's and Standard & Poors, give countries sovereign credit ratings that indicate the risk level of the investing environment of a country. However, finding details of exactly how this is calculated seems difficult – and whether it is partly based on the elusive concept of trust another issue.

Certainly, their decisions are felt on the markets, although ratings agencies have been widely criticised for having too much clout in jittery markets during the financial crisis. They were widely attacked for failing to warn of the risks posed by certain securities, in particular mortgage-backed securities.

Losing your rating or being downgraded can, in some cases, have a fatal effect on your country's ability to borrow money on the markets. But this depends on which country we're talking about. Here Wikipedia explains and details which country has which rating.

 

So it is important to hang onto triple-A?

In early August, Moodys warned that the UK could lose its rating if it pulled back on its spending reduction plans. Over a year ago the situation was even worse as markets worried about a hung parliament and the effect it would have on austerity plans. Osborne continues to hang onto this status, but perhaps this isn't important anymore, say commenters – when building trust and honesty is key for the country.

Barncactus comments on Mindful Money economist Shaun Richards' blog: "Some straight talking would not go amiss at this time, though I guess that Osborne has the self-inflicted constraint that he is trying, probably in vain, to keep our AAA rating in force.

"I can't for the life of me see why the bond markets allow that rating to continue given the rocky state of the nation's finances, and it seems rather likely to fall a couple of notches fairly soon. Once that has happened, then perhaps we can start calling a spade a spade and the forecasts can start to look credible for once."

But Michaelfoddy adds on the blog: "Everything is fine in the UK bond market and the AAA rating will remain intact so long as the BoE continues to buy virtually 100% of bond issues. In other words UK is self financing – simple!"

 

The importance of self-financing

While banks continue to borrow using Britain's triple-A credit rating, would it really matter if we lost this? After all, the fact Britain has its own currency means we can borrow (self-finance) and instigate further bouts of quantitive easing, whether this is wise or not.  

Simon Ward, Henderson's chief economist and Mindful Money blogger, says: "Sovereign credit ratings are pretty meaningless – at least for countries borrowing in their own currency with their own central bank. Such countries will always print money rather than "default".

"The low level of gilt yields is not due to our triple ‘A' rating but instead reflects Bank of England intervention, forced buying by banks under regulatory pressure and capital flight from the euro area. The market, in other words, has been distorted and should not be viewed as having delivered as a vote of confidence in the coalition's fiscal plans.

"The rating process is farcical but there must be a good chance that one of the agencies will take the plunge and downgrade the UK next year. The impact would probably be minimal – as it was in the case of S&P's US downgrade this year."

 

History demonstrates lack of meaning

Here is Bill Gross of Pimco commenting on the usefulness of the rating agencies in 2010 when they still held Spain as a AAA credit:

"Take these recent examples for instance: S&P just this past week downgraded Spain "one notch" to AA from AA+, cautioning that they could face another downgrade if they weren't careful. Oooh – so tough! And believe it or not, Moody's and Fitch still have them as AAAs. Here's a country with 20% unemployment, a recent current account deficit of 10%, that has defaulted 13 times in the past two centuries, whose bonds are already trading at Baa levels, and whose fate is increasingly dependent on the kindness of the EU and IMF to bail them out. Some AAA!"

Seeking Alpha adds: "Don't you wish you had bought some long term Spanish debt in 2010? I mean it was rated AAA so there was virtually no risk according to S&P. Instead the downgrades on Spanish debt arrive when everyone with electricity and a television alread
y know about the elevated risk."

Turning to individual companies, do you remember Enron? Enron's credit rating was still considered investment grade four days before the company declared bankruptcy.

Stitchups comments on a Guardian report generally on credit ratings: "At best it seems ratings are standard, and at worst, they are sometimes very poor.

"As I began, with the self-fulfilling prophecy factor taken into consideration, perhaps journalists should give their reports far less credit than they do at the moment…

"That confidence is certainly not based on history. By now we should all be very sceptical about anything coming from any international authority dealing with our money. Formerly lauded financial gurus, such as Alan Greenspan, and organisations like the IMF, have records of consistent failure when they have meddled with nations´ economies. But they have not had to suffer the consequences of their meddling, the ordinary people of those nations have.

"Let´s get real. None of the large financial institutions, their advisors, or any state regulating authority, predicted the present financial crisis, yet all the evidence was there. Economists, who did see it coming, were ignored and even derided."

 

What will it mean for investors if we fail to retain triple-A?

In the short-term it is likely to make little difference for investors. It is unlikely to encourage widespread investment in the UK's stockmarket, which is internationally diversified. Equally, it has had no appreciable effect on sterling. However, in the short term markets would again be rocked.

 

More from Mindful Money:

EU plans rating agencies reform

Do credit ratings matter?

Britain's AAA credit rating reaffirmed, but what difference does it make to investors?

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