24th July 2012
And Henderson notes the knock-on effects in the strong heartland of the Euro – Germany, the Netherlands and Luxembourg where credit rating agency Moody's, has lowered the outlook on these three AAA rated countries. The agency is not downgrading yet, but it has dropped its longer term view from stable to negative watch. This is intended as a warning shot that those countries have to change if they are to maintain their coveted top borrowing status.
This leaves very few countries with AAA with a stable outlook – Australia, Austria, Finland, Sweden, Switzerland, and the United Kingdom are the top performers on Standard & Poor's. Finland is now the only eurozone member with the highest rating on Moody's – Austria went negative last week.
But with just a handful of countries at the very top of the ratings universe, does what the credit economists at Moody's or Fitch or Standard & Poor's think matter any more? It could be that AAA negative or AA positive/stable become the new best grades simply because investors have find somewhere to squirrel their cash. It is all made more complicated because ratings agencies – the three US based which are normally quoted, and China's Dagong which has become more powerful as Asian economies rise, often fail to agree.
China – choose the agency, choose the rating
There is a range of possibilities for many countries. Dagong is the only one to give AAA to China, unsurprisingly for Beijing based firm, while Standard & Poor's comes up with AA for that country, Fitch A+ and Moody goes for Aa3-.
But besides investors having a choice, more importantly, an increasing number are questioning the relevance of the agencies, especially in the wake of the AAA ratings they often gave to the portfolios of sub-prime mortgages which helped bring the first wave of the current economic crisis and turned effectively into junk status overnight.
According to Bloomberg, almost half the time, yields on government bonds fall when a rating action by Standard & Poor's and Moody's suggests they should climb, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as the 1970s.
After S&P stripped France and the U.S. of AAA grades, interest rates paid by the countries to finance their deficits dropped rather than rose. The U.S. 10-year Treasury yield has fallen as low as a record 1.3960 per cent. The agencies argue that their warnings often produce better fiscal behaviour so the dire predictions protect investors in the long run.
Germans hit back at Moody's
The Germans are fighting back against Moody's misery prediction. Bloomberg reported that its government said Germany will remain Europe's haven during the financial crisis as it refuted the decision to lower the outlook on the country's top credit rating.
The German Finance Ministry said the risks in the euro zone are "not new," and that Germany remains "in a very sound economic and financial situation." In counterpoint to Moody's – but looking at the US and French experiences, it cited the verdict of financial markets that have rewarded Germany with record low borrowing costs on government bonds. It added that Moody's is focusing on short-term risks while failing to mention longer-term prospects of stabilisation.
But while there were small initial falls in Dutch and German bond values – pushing up yields by some 10 basis points (0.1%) – it is unclear whether this was a reaction to the Moody's announcement or to more generalised worries over Spain's position in the eurozone. German yields are still near all time lows.
In a statement, Moody's said that risks that Greece may leave the euro and an "increasing likelihood" of collective support for European countries such as Spain and Italy were among reasons for the downgrade.
"Given the greater ability to absorb the costs associated with this support, this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form," Moody's said.
No surprise in ratings statement
But this is a statement of the obvious. There can be few investors who do not get that far – unlike the high water mark of the agencies during the sub-prime boom and bust. It was only the high ratings that allowed investment banks to sell dross dressed up as gold, who gave AAA ratings to garbage liar loans.
And even one credit agency now questions their power. Dagong, increasingly the voice of non-Western debt ratings, asks whose interests are served by the big three. It writes:
"As the credit relationship is established according to the rating information, so the quality of information provided by the international credit rating system decides the status of the international credit system. Practice and studies indicate that the social credit relationships are virtualised and have bubble qualities because the current international rating system continuously outputs wrong rating information; every credit relationship unsupported by real solvency in the international credit system faces debt repayment crisis, with the rupture of the U.S. subprime loan credit relationship – the most vulnerable section in the global credit chain as the breach. The direct indication of credit crisis is the deleverage of funds supply, which makes the parties concerned amid the credit chain in a funds-exhaustion status of crisis."
In other words, there is a circularity of problems being worsened by ratings cutbacks which, in further turns of the screw, add to the difficulties of countries or corporates already under pressure.
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