March 31st Lunchtime: The Recession Diaries

My oh my. Standard and Poor’s (S&P) has downgraded the Irish Government’s credit rating – from AAA to AA+. The fiscal reactionaries are in party-mode.

‘We told you so, we told you so, we’ve kept borrowing and now our credit rating has fallen, we gotta cut, gotta cut fast, gotta cut deep or we’ll lose that ‘+’.’

Of course, anything that impedes our ability to borrow on the international markets, anything that increases the cost of our borrowing, is not good news. And there is no doubt the S&P downgrade will make it difficult for us. So how should progressives respond?

First, laugh out loud at S&P. Second, laugh out loud at anyone who takes this type of agency seriously. For S&P, like other credit rating agencies, are wholly discredited to the point that serious analysts suggest they should be abolished.

That anyone anymore takes these credit rating agencies seriously is a mystery – and not just to me. S&P, Moody’s, Fitch’s – aren’t these the same agencies that gave a big two-thumbs up to the sub-prime mortgage investments? Giving the credit derivatives based on these flawed assets the big green light? Weren’t these the biggest cheerleaders for financial products that pretty much sunk the international financial system? Yep, the very same.

Credit rating agencies assigns ‘ratings’ for certain types of debt obligations: corporate as well as Government debt. The ratings are used by investors to asses the creditworthiness of the company or government in question. This is a big responsibility –commenting on creditworthiness. So you’d think they would be pretty careful and, above all, independent of any financial pressures or conflicts of interest. You’d think.

The US Congress held a special investigation into the conduct of these rating agencies The CEOs of the big three – Fitch, Moodys and S&P – were grilled by Representatives about their conduct and business model.

‘Conflicts of interest were largely responsible for the disastrous performance of credit rating agencies in assessing the risks of mortgage-backed securities . . ‘

And

'The three major credit-rating companies assigned some of their highest ratings to mortgage-backed securities whose risks were grossly underestimated. As homeowners began defaulting on subprime mortgages, it became clear that many of those securities were overvalued. The companies finally downgraded thousands of those securities over the past year, contributing to the collapse of major firms and heightening the economic crisis.'

Not only did the agencies help grow the bubble, then they assisted the collapse. What a great bunch. The Democratic chair of the committee, Representative Harry Waxman was blunt:

‘The story of the credit rating agencies is a story of colossal failure. The credit rating agencies occupy a special place in our financial markets. Millions of investors rely on them for independent, objective assessments. The rating agencies broke this bond of trust . . .’

Through testimony of former employees (the former head of mortgage ratings at S&P characterised the failures at that company by saying simply: ‘Profits were running the show.’), access to board minutes and confidential e-mails and memos, the Committee uncovered a cesspool of irresponsibility and culpability.

‘Among the documents uncovered by the committee was an internal board presentation delivered by Mr. McDaniel to Moody’s directors. .. he told his board: Analysts and managing directors “are continually ‘pitched’ by bankers, issuers, investors.” At times, he conceded, “we drink the Kool-Aid.”

The credit agencies became shills for the very people they were supposed to be independently rating. And this is the reference to Kool-Aid.

Everyone knows that Congressional Democrats and Republicans can’t even agree on the colour of the sky. Bi-partisanship is a four-letter word there. But let’s applaud the credit rating agencies – they managed to bring the Congressional Committee together in a unanimous condemnation. Republican Rep. Christopher Shays stated:

"When the referee is being paid by the players, no one should be surprised when the game spins out of control. You have so screwed up the ratings as to not be believable.’

Keep that in mind – a representative from one of the most pro-business political parties in the Milky Way, stating these agencies are not to be believed. No wonder Paul Kedrosky asks:

‘So, do we reform the credit ratings agencies? Sure. . . .But why stop there? Why not reform them right out of existence? We don't have a rating requirement elsewhere in financial markets, let alone in the real world. There are no government-certified equity or mutual fund ratings agencies, even less restaurant ratings agencies, or bicycles. So why do we have credit ratings agencies?’

While Michael Lewis and David Einhorn writes in the New York Times:

‘Given their performance it’s hard to believe credit rating agencies are still around. There’s no question that the world is worse off for the existence of companies like Moody’s and Standard & Poor’s.’

So what does all this mean for government borrowing and the intervention of the rating agencies? Professor Gerard Epstein, co-director of the Political Economy Research Institute, writes provocatively:

‘The credit rating agencies have got us coming and going. First they help cause the biggest economic calamity since the 1930's. And now they tell us we can't take the fiscal measures needed to get us out of this mess. Meanwhile, they are laughing all the way to the bank (that is, if they can find one that is still solvent). Why are we still listening to them? . . . Yet now, S&P and Fitch are sending "credit warnings" to other governments, threatening to downgrade their sovereign debt ratings if they "allow" their fiscal deficits to increase too much.’

Epstein’s analysis is worth noting. He suggests that smaller countries are being targeted, not because of their fiscal situation. Rather, the real target of the agencies is the larger countries – the US, UK, Germany, etc. Smaller countries like Greece, Portugal and Ireland are just collateral damage in what is essentially an ideological-driven attack. For credit rating agencies – ironically the beneficiaries of a US government licensed and protected oligopoly - are bastions of fiscal conservatism with a mission to attack expansionist stimulus:

‘ . . . increasing spending and fiscal deficits in the short run is exactly what governments should be doing. And now, after helping to cause the crisis, the credit rating agencies are blocking the way to the solution. The actions by S&P (threatening to downgrade Government bonds) are therefore profoundly misguided and potentially destructive. . . . This credit ratings fiasco picks off the weakest countries one by one and sends warnings to the stronger ones - an anti-Keynesian divide-and-conquer strategy.’

S&P’s assessment of Irish borrowing risk is not based on any ‘independent’ analysis (any more than their ‘independent’ analysis of sub-prime mortgage assets). Does anyone really believe that Ireland or any other Eurozone country will, or be allowed to, default on its debt? It is political. And it’s not even directed at us. We’re just pawns. Unfortunately, we could suffer depending on how many investors are duped by these Borats of the financial world.

To paraphrase the maxim: ‘Big credit rating agencies do what they want; small nations do what they can’. All we can do is work to our own lights and provide as much support to the National Treasury Management Agency as possible in their work to continue borrowing and at lower costs to the taxpayers. So let’s ring the banks into public ownership (to get the bank guarantee monkey off our backs) and launch a stimulus programme to put a floor on the economy that is sinking like boulder.

And if, on the way, a Government Minister exposes the game that S&P and other discredited rating agencies are playing, telling them they can take their ‘+’ and stuff it – then they will have my fullest, unconditional and grateful support.

Comments

[Gerard O'Neill]

"credit rating agencies – ironically the beneficiaries of a US government licensed and protected oligopoly"

Kinda significant point there Michael that you slipped by. Maybe a case for less government intervention for a change?

And yes, let's get rid of all rating agency licencing and let the market figure it out for itself.

[Longman Oz]

The general reaction today to the one notch downgrade is quite disproportionate to what it signifies and suggests a lack of understanding of what credit ratings actually mean.

For example, some economists have been predicting that we will be bankrupt within months. If S&P in anyway agreed with that view, we would have been cut several more times over already. Instead, they see AA as only being a small bit different to AAA (source - their website).

In context, Ireland retains the second best place on a 22-notch scale, where only the last place means that a payment default has already occurred.

Moreover, the truth is that the market has long ceased to view Irish debt as being AAA-equivalent, given that our borrowing costs have been higher for months now compared to other AAA-rated countries.

Indeed, the fact that the FT reported it as a two-inch story in its news digest tells you how "old news" this downgrade is in terms of the international perception of Irish sovereign risk.

What the downgrade will mean, though, is that certain types of low-risk investors will no longer be permitted by their internal regulations to invest in Irish debt.

Anyway, a 1 or 2 notch downgrade has seemed like an inevitability ever since that deficit began to bloom and the banks risked collapse last Sept/Oct. The real question to ask is where will these downgrades end? Again, watch our debt pricing against those of other countries of a similar rating for a heavy clue on that.

[Pavement Trauma]

If the credit ratings agencies really had it in for us, they would have downgraded us a lot faster and a lot more notches than they have. God knows there is evidence enough of the deterioration in our credit worthiness.

For all their evident faults and conflicts of interest, I don't think it is credible to say credit rating agencies have a distinct 'political' agenda as such. They support 'fiscal conversatism' because that is what benefits their customers - those institutions that provide credit to others, whether sovereign or otherwise.

Does anyone really believe that Ireland or any other Eurozone country will, or be allowed to, default on its debt?
I don't think it is likely, but it is possible. We don't know how long or deep this recession is going to be.

[D_D]

1. S&P are at the centre of the financial complex that created this mess.
2. The abstraction of "the international markets" is being used as a bogey man to frighten us into accepting austerity. Again, it was "the markets", at home and away, that caused the crisis.
3. Interest is money for having money. Big interest is a form of theft. Increasing interest charged in proportion to the borrowers difficulties is increasing extraction in proportion to weakness.
4. A resolution to crises is not the satisfaction of "the international markets" but the ending of dependence on "the international markets" (the international bankers and financiers) and of their economic power.

[Pavement Trauma]

D_D: We have a large budget deficit, that means we need to borrow a large amount of money. To a large extent we borrow this money in "the international markets" that is from pension funds, banks, insurance companies, mutual funds etc. They do not have to 'risk' their money by lending to us, they risk it to get a return - the interest. The higher the perceived risk of lending to us, the higher the interest we pay.

[D_D]

PT: This is a description of the situation which I suggested needs to be transcended if it is not to be continually repeated.

The large budget deficit did not just happen either. It is the result of a low-tax (to big business and big earners) economy, the collapse of revenue from a construction and building bubble and the recessionary effects of the international crisis of which the listed institutions are a direct cause.

'We' seem to have dealt with the banks' deficits without the need to borrow. Is there more of that money to help with the budget deficit?

[Pavement Trauma]

The way to end our dependence on the "the international markets" (the international bankers and financiers) - to use your phrase - is to run government surpluses until our national debt is reduced to a neglible size. Good luck with making that argument in the current environment.

--'We' seem to have dealt with the banks' deficit without the need to borrow.
'We' (recklessly in my opinion) gave explicit guarantees over the banks' debts that if any substantial proportion of them were ever to be called in, we'd be bankrupt quicker than I can spell check 'Reykjavic'. The banks' deficits are not nearly sorted out yet.

I don't particularly disagree with you about the causes of the various crises. For now the market of matching lenders and borrowers is conducted by many of the same institutions culpable for the mess the world is in. We would still be in the same fiscal pickle if it was the Salvation Army dishing out the loans. The fact is people lending out money want to be paid back - and with interest. We could choose not to pay them back by defaulting on our national debts but the consequences of that would be worse again. Any alternative suggestions you might have are welcome.

[Michael Taft]

Yes, Gerard, I thought you might pick up on that. But don't forget, I helped write the ATGWU document calling for electricity prices to be set by the market (and we were labeled left-wing!). I have never made the mistake of confusing neo-liberals with doctranaiire fiscal conservativism or pro-competition. Finance and multi-national capital is quite willing to argue for large government spending (bail-outs, Iraq war contracts) and limit competition when it suits them. Ultimately, the argument is about power.

Longman Oz, excellent points. This is a long-game - it would help if we could change managers at half-time.

D_D - excellent synopsis, brief and to the point. You should write a blog of you own. We need more clear-headed analysis like that out in the world - even the blogging world. I'd link to you.

Pavement Trauma - I don't doubt the problems this will create for us. After all, this is the man's world. You state 'They support fiscal conversatism because that is what benefits their customers'. That may be true but as the US Congressional hearings showed, their first interest wasn't their clients nor probity. Their sharp practices were such that it was difficult to determine who benefitted - except, of course, their collective bottom line. Yes, we will have to borrow - but financial perception is as much political perception as anything else. We need a politics that is concerned with ending the recessionary decline, put people back to work and bring the banks into public ownership to sort out financial system (and be seen to be doing so). That would help not only the NTMA but more importantly - everyone living in this country.