US credit rating downgrade threat – is Moody’s embroiled in US politics?

3rd June 2011

Here is a link to the Moody's website announcing the decision and the story as reported in the Wall Street Journal.

At the heart of the debate is that fact that President Obama and his fellow Democrats and Republicans cannot agree on the level of the debt ceiling and are also at an impasse over whether the deficit should be cut through tax increases or spending cuts.

The key quote from Moody's is the following – "Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review."

But to see how intensely political this debate has become, The Atlantic associate editor Daniel Indiviglio argues Moody's, whether it wishes to or not, has sided with the Republican party.

First Indiviglio quotes this statement from Moody's Senior Credit Officer David Hess. Hess says: "The negotiations now on deficit reduction over the medium term are a significant opportunity to actually do something on that front. Although fundamentally, the debt limit question is separate from long-term deficit reduction, they seem to be linked at this point in Washington. The chances of them coming to an agreement, we think, are much reduced if this opportunity goes by and nothing happens."

This is Indiviglio's view –

"This must infuriate Democrats. For months they have been complaining that the debt ceiling debate is a ruse on the part of Republicans to create an issue out of a procedural necessity. Now, however, it looks like one of the rating agencies is siding with Republicans. Hess here essentially says that if legislation raising the debt ceiling doesn't include a plan for long-term deficit reduction, then the firm will view Washington's inaction as a problem."

Others also suspect a right wing play – Here in an interview with Press TV Paul Craig Roberts, a former assistant secretary of the US Treasury, believes the announcement only plays into the hands of Wall Street which, he says, wants to privatise pensions and healthcare in the US.

This side of the Atlantic, in the Guardian commenters are unsurprised by the decision.

sharkfinn is exasperated and writes: "This is LONG overdue. But what is really happening is that we are gearing up to the end of quantitative easing, which ends at the end of the month, and the stock markets are going to fall back (note "back", not down) to where they should have been before QE1 and QE2. This downgrade threat is all part of the game to force QE3. Then what will happen is QE3 will be rolled out silently and the artificial economic stimulus will continue. And shares and gold will rise again as the money in our pockets continues to be worth less."

However Phalanxia isn't happy at the continued power of the ratings agencies.

"It's absolutely scandalous how anyone still listens to these agencies after their disgraceful and catastrophic failure to accurately rate the solvency of plenty of de facto insolvent institutions and governments prior to the financial crisis. If I didn't think they were just incompetent, I'd accuse them of having an explicit political agenda in this latest criticism of the Obama Administration."

But what does it mean for investors?

Mindful Money found that many websites are still digesting the news. But here financial research organisation Morningstar's director of fixed income research Eric Jacobson discusses what the previous ratings warning from S&P meant for investors. We'll bring you more on this story later.

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