And I say that as someone who works closely with them day to day. It's also the only negative thing I'm going to say about the agencies (probably) in this post.
There's a lot of hatred for them right now and it's of the shameful 'shoot the messenger' variety. Shameful because, for once, they're standing up and telling the truth. Setting aside that it's only one of the three global agencies demonstrating any real cajones, this is what they're supposed to do.
I was recently in the States and in discussing this with a number of very well informed players there I was stunned at the level of willful denial, delusion and dissimulation regarding the state of the US economy and political system. Sure I'm going to be unpopular for saying this - but from the outside world the US currently looks like a banana republic on the decline. The real tragedy is that it doesn't have to be this way. The US is awesome but right now it's destroying itself rather than be bold. Much of this comes from some popular idea of individualism (sometimes dressed up as 'bible believing' Christianity - which it most assuredly isn't). Really it's bible believing Ayn Randism...if you'll forgive my murdering of the language. It's like huge swathes of people have swallowed Atlas Shrugged with their mother's milk and no one ever gave them their shots.
Sorry, I'm drifting. The agencies, and S&P in particular, are speaking the truth. It's not about politics (except in so far as US politics is driven by Big Business) it's about economics and the US is locked into what seems to be a tragedy of the commons. Everyone wants what's 'theirs' but no one's willing to pitch in to make that possible.
The function of an agency is to voice an opinion (and it is just an opinion) on the probability that an investor will get their money back if they invest in a particular risk. If that's IBM then fine but what we have here is the real problem.
At the heart of the financial and economic regulatory system we have the idea of Ratings, propounded by economists, politicians and sovereigns for the last 40 years, the Ratings Agencies have been put solidly in the centre of this framework as the gold standard. I mean, come on, we've enshrined it into the heart of our global legal system. To complain that now the news is bad the bringers of that news are to blame is to willingly engage in ignoring the truth. But the truth won't go away no matter how loudly you shout at those speaking it. Sure they may be made to shut up but that's just silencing the voice giving expression to the facts. As Canute would tell you were you his advisers...facts have a habit of doing what they will whatever 'truth' you construct for yourself.
Should S&P be hated? No. Should they be taken seriosuly? In this instance...Yes. Where are Fitch and Moodys right now? Good question. Still, it's always useful to know there are other opinions available.
S&P's downgrade is only telling me what I, and everyone in my industry already knew, the US is a profligate wastrel and who can't balance it's books. Who refuses to balance its books. Yet we're the ones who've put them at the heart of our process. If our markets tank because of their news we have only ourselves to blame; on two fronts.
Firstly, they're speaking the truth as they see it
Secondly, we've geared our international legal framework to take their words as gospel.
If we don't like it we should put them in a more tenable position, as pundits with authority, not as legally enshrined gatekeepers to economic well being.
Let me be clear...S&P aren't to blame for this downgrade. We are. Nor are they solely to blame for the potential impact of this ratings action...we are. After all, we're the ones who gave them the seat at the head of the table. I'm sure it seemed like a good idea when the thought of a US downgrade appeared as outlandishly ludicrous as Lehman Brother's going bust.
nb. I could make this post substantially more technical, going on about risk free rates, IFRS, regulatory capture, risk weightings, CRD, BIS, Basel, Money Markets, Market Makers, Fund Investment Criteria etc etc. But I was aiming to make something everyone can understand. I'm sure some people will assume that because I haven't been technical I don't get it. Trust me, I can technique your arse, this blog is simply the wrong medium for considering the hardcore theory being played out live before us right now.
Ok I'll bite. I am wary of doing so as I am by no means a finance expert. I do know a thing or two about politics though so will be mostly commenting on that basis.
ReplyDeleteSeems to me that the S&P downgrade is as much a political comment as an economic one. I see lots of words in their quoted statement referring to stability and credibility of governance. The behaviour of the US government in this crisis and more generally has indeed been poor but who are these people and what qualifies them to comment and more importantly why should we listen ?
Their prognosis seems to be that the medicine proposed by congress is too sugar coated, not aggressive enough to solve the disease and the doctors too weak willed to last the course as the patient squirms in pain.
They may be right but is it their place to comment ? Their stated role is to comment on the likelihood of a credit default on issued bonds. I have seen little to suggest that political brinkmanship aside that this is a realistic proposition and certainly nothing that would indicate that the actions determined make this more likely.
This indeed seems to be a crisis provoked for the most part by the political class in the US. The tea party crazies have turned a non issue into a crisis based on their ideological hatred of state action.
There is a broader context here though. The S&P medicine is to cut spending harder, raise additional revenue. This is basically the financial equivalent of cold turkey, it hurts, big time, let's be clear it will chew up the lives of thousands of innocent families and spit them out.
Is there an alternative ? I believe there is. If I can be forgiven in engaging in a housewife metaphor the alternative to slashing the housewife slashing the family budget is for the wage earner to seek a pay rise or a better job.
This alternative has to at least be credible right ? The world needs goods and services, technology continues to progress and create challenges and opportunities, peak oil, climate change all create huge economic opportunities and niches to be filled. Surely the opportunity to grow our exports therefore exist earning us additional income with which to pay down our debts.
Seems to me therefore western democracies stand at a crossroads managed decline, slashed budgets, higher taxes and a bleak future or investment, rebalancing of our economies away from a reliance on financial services and traditional industries towards niche highly value add products and services.
The credit agencies would seem to have taken sides in this debate by supporting the policy agenda of managed decline. It doesn't seem unreasonable to question their motives and whose interests they serve.
There's a fallacy in the argument - that the politics has no impact on the likelihood of a default. As far as I can see it has a massive impact. Indeed, the unwillingness to appropriately increase the national revenue base whilst also not allowing for appropriate measures to curb (or at least moderate) spending is massively important.
ReplyDeleteThe second fallacy is that S&P aren't qualified to speak to the issue. Yes they are. So am I and to some extent, so is everyone. It's called free speech. At least I think it is. Calls for them to shut up smack of censorship.
The issue I have is that they should just be treated as journalists. The problem is that we (that is the financial industry) has put their ratings at the heart of the financial industry as gold standards and thereby elevating their words to cast iron judgements. We can't blame them for the actions of the market in putting their analysis at the heart of the industry.
Interestingly your housewife analogy is exactly the one George Osbourne has chosen hoping it will take the UK out of its structural problems. Real terms decreases in spending are limited to just 0.5% (I can reference this if you like) across government with cuts in government debt actually coming from projected increased tax revenue - which is now very much in doubt.
ReplyDeleteThe US could address the fact that up to half its working population pays effectively a zero rate to federal government. It won't. It probably can't. That's the politics making it much more likely that the US government will default.
Managed decline is part of the inevitable outcome of applying Friedmanesque policies at this juncture - unfortunately the Chicago school remains ascendant despite the fact it's almost wholly responsible for the current crisis.
The alternative, which is at least as risky, would be to invest for growth. THe problem is that growth takes time to feed through - much too much time given the challenges facing governments right now.
I suspect both China and the EU are at least a little glad that the US lost it first - although the knock on is going to hit us all hard.
Fair points on the free speech. They know they are gatekeepers though not just commentators and whether that power is right or wrong with it comes some responsibility.
ReplyDeleteI am aware our cutbacks are pitiful, I think in all sorts of ways we are far to profligate with our resources. The issue is to cutback on wasteful spending so we can afford to invest in a new economic base.