What An S&P Sovereign Debt Rating Is Worth

Via Dean Baker, a hill of beans:

Look at the chart - AAA S&P rated Australia's 10 year bonds are yielding 4.9%. A- S&P rated Malaysia's 10 year bonds are yielding 3.9%. AA- rated Japan's 10 year bonds, and currently holding a negative watch from S&P, are paying 1.1%. AA- China's 10 year bonds, currently S&P rated stable, are yielding 4.1%.

While as a general matter, the countries S&P has chosen to rate AAA face lower interest rates than countries with lower ratings, there is so much randomness that it is difficult to attribute any cause to S&P ratings. I think no one seems to pay attention to S&P on sovereign debt ratings. More . . .

I think the reason for this is that S&P gives out ratings in subjective ways, on a country by country basis. There is no apples to apples comparison of creditworthiness between nations. It's more along the lines of S&P does not like what a particular country is doing therefore it will downgrade their rating, irrespective of an actual creditworthiness analysis.

I used to think that even if S&P ratings were inaccurate, even a drop in an inaccurate system would reflect some effect on the interest rate a country might pay. But now I'm not so sure.

S&P is threatening to downgrade US debt if it is unhappy with the debt ceiling deal that is cut. I wonder if they will do it. My bet is no, because it would reveal that S&P sovereign debt ratings are meaningless with regard to the United States. I don't think they'll take a chance on that.

Speaking for me only

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    The ratings agencies exist to... (5.00 / 2) (#2)
    by Dadler on Wed Jul 27, 2011 at 10:17:15 AM EST
    ...telegraph their ratings to their cronies, who can then make their rigged insider bets.  This is the sole "function" they serve.  That U.S. Reps and Senators and their employees can legally trade on insider information all they want to, sigh, there is little chance anything having to do with real, as opposed to imaginary, financial regulation will ever occur.

    The opinions of rating agencies (5.00 / 2) (#3)
    by Militarytracy on Wed Jul 27, 2011 at 10:51:18 AM EST
    aren't worth much these days.  Everyone can buy CDS so believe in anything you want and believe whatever you want.

    I like (5.00 / 2) (#4)
    by jeffinalabama on Wed Jul 27, 2011 at 10:56:27 AM EST
    CD's, but switched to DVR's ;-P

    Ohh nooes, not CDS again (5.00 / 1) (#5)
    by Towanda on Wed Jul 27, 2011 at 11:10:09 AM EST
    So the debt ceiling "crisis" is all the Clintons' fault, too!

    Don't you remember, Towanda? (none / 0) (#6)
    by jeffinalabama on Wed Jul 27, 2011 at 11:15:34 AM EST
    Clinton is, "Da Debil!"

    To me? (5.00 / 6) (#7)
    by kdog on Wed Jul 27, 2011 at 11:21:58 AM EST
    Absolute nuthin'...less than nuthin'.  S&P can disappear for all I care about their racket.

    But I ain't tryin' to turn money into money unless horses, cards, or croupiers are involved.  Aside from that investment-entertainment, I'm trying to turn money into food, a roof, and fun.  And even if I were into injecting steroids into dollars to make them multiply, I wouldn't be consulting with no Standard & Poor's...their standard is poor.

    Extremely well played. (none / 0) (#8)
    by jeffinalabama on Wed Jul 27, 2011 at 11:30:38 AM EST
    Comment and a 5.

    our People's Poet, kdog, is on a roll (none / 0) (#15)
    by The Addams Family on Wed Jul 27, 2011 at 12:56:43 PM EST
    A ratings change will have a ripple effect (5.00 / 1) (#11)
    by steviez314 on Wed Jul 27, 2011 at 12:31:15 PM EST
    more than it might affect US Treasury interest rates.

    Many bond funds have a target blended rating they must achieve.  Let's say they need an "average" A rating.  So they can buy B rated corporate debt along with AAA US debt to get there.

    If the US becomes AA, these funds might have to jettison some lower rated debt to keep their average at the target.

    Even if US rates don't change, so much is tied into the "US=AAA".  Even thought the ratings agencies are idiots, they're still the official scorers.

    Can you consider me ignorant (none / 0) (#13)
    by jeffinalabama on Wed Jul 27, 2011 at 12:47:41 PM EST
    and explain it? Because I am ignorant and don't understand government bonds much more than the absolute basics.

    Many mutual funds, hedge funds, ETFs, are (5.00 / 2) (#19)
    by steviez314 on Wed Jul 27, 2011 at 01:15:44 PM EST
    required to holding bonds the way they say it in the prospectus.

    So, if a fund says "we hold only AAA rated securities", then the chart above means nothing.  The ratings agencies being idiots means nothing.  If they rate it AAA, the fund can hold it.  If not, not.

    Other funds and investors shoot for an "average" rating, so they mix AAAs with lower rated debt (usually corporate).  So if the US loses its AAA, the funds "averages" will go down, and they will have to adjust by selling some of their crap.

    There is so much tied into the US Treasury AAA rating in terms of other borrowers and issues, that I just don't know what kind of ripple effect there would be.  

    Even though the ACTUAL credit of the US hasn't changed, too many investments have allowed the ratings agencies to be the final scorecard.

    It's like the mirror image of the agencies rating mortgage crap as AAA so other idiots could buy it.


    The reason (5.00 / 1) (#24)
    by Warren Terrer on Wed Jul 27, 2011 at 01:34:55 PM EST
    ratings agencies have been given such power with respect to rating government debt is because government debt is always AAA because is has no involuntary default risk. Nothing is safer than US government debt, as it is the only borrower of US Dollars who can never default. So ratings agencies were left the power because it was seen as really no power at all. No one factored in the lunacy of the government voluntarily defaulting because of the nonsense over the debt ceiling, because the debt ceiling has always been raised whenever required.

    This leaves the agencies in a bit of a bind if the US government can't get its act together on the debt ceiling.  There's no way there will be anything other than a temporary default anyway. Should the agencies lower the rating and force a pointless sell-off of government debt, or just leave it at AAA knowing that eventually the government will remedy the default, thereby admitting that their ratings of government debt are actually meaningless? I think most will go for the latter choice.

    In future, drafters of prospectuses should define all federal government debt as AAA to begin with and not leave it up to the private ratings agencies.


    What does PIMCO do? (none / 0) (#21)
    by Big Tent Democrat on Wed Jul 27, 2011 at 01:21:10 PM EST
    Whatever they want to. (none / 0) (#23)
    by steviez314 on Wed Jul 27, 2011 at 01:31:30 PM EST
    Actually, I wouldn't be surprised if their funds have lots of flexibility and aren't focused on official ratings.

    I mean, Bill Gross even went short treasuries for a while this year (wrongly).

    But US Treasury holding are SO vast, that a ratings change should change a lot of weighted-average portfolio ratings.


    Yeah (none / 0) (#26)
    by Warren Terrer on Wed Jul 27, 2011 at 01:39:08 PM EST
    Pimco trades mostly on its own account doesn't it? Therefore it has no contracts that reference ratings by outside agencies. It does its own ratings, sometimes wrongly as you point out.

    Not their money. They have over $1 Trillion in (5.00 / 1) (#29)
    by steviez314 on Wed Jul 27, 2011 at 01:43:42 PM EST
    assets under management--from pension funds, investors, etc.

    They're really just a Fidelity that specializes in bonds.  

    But since they are so well known and perceived as experts, I'm sure they have more flexibility in their holdings than smaller outfits.


    That's interesting to know. (none / 0) (#30)
    by Warren Terrer on Wed Jul 27, 2011 at 01:44:44 PM EST

    PIMCO (none / 0) (#25)
    by CoralGables on Wed Jul 27, 2011 at 01:37:25 PM EST
    has about 75 different investment funds. You'll have to be much more specific.

    Are those mutual (none / 0) (#28)
    by Warren Terrer on Wed Jul 27, 2011 at 01:41:34 PM EST
    funds? I'm don't know. All it invests in is government debt afaik so I don't know why it needs ratings agencies. PIMCO is supposed to be its own expert. But I am curious if it runs any funds that are subject to these outside ratings.

    I think you tocuh on somethng important (none / 0) (#33)
    by Big Tent Democrat on Wed Jul 27, 2011 at 01:56:53 PM EST
    Government bonds are not really found in funds subject to rating agency whims.

    If what you are trying to say (none / 0) (#36)
    by me only on Wed Jul 27, 2011 at 02:24:18 PM EST
    is that mutual funds don't bother with the rating on US Treasuries, it appears that is correct.

    Depnds on the fund (none / 0) (#27)
    by me only on Wed Jul 27, 2011 at 01:39:09 PM EST
    PGOVX doesn't seem to care about US Treasuries, but it does appear to care about other municipal bond ratings.  W/o going through each prospectus it would be difficult to say what "PIMCO" does.

    Whatever relevant fund they run (none / 0) (#32)
    by Big Tent Democrat on Wed Jul 27, 2011 at 01:55:52 PM EST
    What do they do?

    They run a lot of funds (none / 0) (#34)
    by me only on Wed Jul 27, 2011 at 02:15:15 PM EST
    The PGOVX is the "PIMCO Long-Term U.S. Government Fund".  Based on that prospectus (as I read it) it doesn't care about the rating of the Treasury Bond.  It cares about the rating of all other municipal bonds, but not the treasury.  The reason should be obvious, we can only default on the treasury if we are stupid enough to do so voluntarily.  Who could possibly be that stupid?


    I don't invest with PIMCO because to say that their prospectus basically read like, "we can do just about anything with this fund."


    Thanks (none / 0) (#38)
    by Big Tent Democrat on Wed Jul 27, 2011 at 02:39:39 PM EST
    I think that is almost certainly how most major investors treat it and explains why the S&P rating may not be all that.

    I only caution this because (none / 0) (#40)
    by me only on Wed Jul 27, 2011 at 03:00:52 PM EST
    I cannot understand CALPERS requirements on bond ratings.  I don't know if the various pension funds have obligations that could be harmed by a downgrade.  If you know a corporate lawyer you might have them read the info that CALPERS publishes.

    At least one source (World Stupidest Web Site) thinks that the bond vigilantes are waiting for the pension funds are going to have to unload Treasuries if there is a downgrade.


    Buy CDS like everyone else does? (none / 0) (#45)
    by Militarytracy on Thu Jul 28, 2011 at 12:02:11 AM EST
    Here you go BTD (none / 0) (#46)
    by Militarytracy on Thu Jul 28, 2011 at 12:07:10 AM EST
    PIMCO on credit default swaps.  Doesn't matter much what anything is rated these days if you are cool buying the insurance that won't work because it will bankrupt everyone in the midst of a major meltdown :)

    Thanks. (none / 0) (#22)
    by jeffinalabama on Wed Jul 27, 2011 at 01:22:17 PM EST
    That explanation helps tremendously. When I don't know something, I ask, because I'd rather not nod my head and think, "What the f**k are they talking about?"

    Ratings have no effect (none / 0) (#1)
    by Warren Terrer on Wed Jul 27, 2011 at 10:14:15 AM EST
    on interest rates because there is no actual default risk on bonds issued by monetarily sovereign countries. Zero. The only risk is inflation.

    Rates on government bonds remain low in spite of S&P ratings because investors see that the economy is going to be bad for a long time and that inflation will remain low for a long time to come. They pay no attention to the ratings of these agencies.

    Do the ratings give the banks cover (none / 0) (#9)
    by ruffian on Wed Jul 27, 2011 at 11:50:38 AM EST
    to raise interest rates though? I was wondering about that.

    "there is no actual default risk on (none / 0) (#10)
    by coast on Wed Jul 27, 2011 at 12:11:07 PM EST
    bonds issued by a monetarily sovereign country" - what exactly are you saying?  If there were no risk there would be no market for CDS on government bonds.  Yet there is such a market due to the fact that countries can most certainly default (or sometimes restructure their debt which is akin to default) on their debts.

    Monetarily sovereign countries (none / 0) (#14)
    by Warren Terrer on Wed Jul 27, 2011 at 12:56:27 PM EST
    which means countries that issue their own currency, cannot involuntarily default on their debts. The can always create money whenever a debt needs to be paid. It makes no difference that there is a CDS market. This does not change the fact that involuntary default is impossible in a monetarily sovereign country.

    You're correct that they can not (none / 0) (#18)
    by coast on Wed Jul 27, 2011 at 01:08:07 PM EST
    technically involuntarily default on debt issued in their currency.  But they can and have certainly voluntarily defaulted and they can involuntarily default on foreign currency debt.

    They can (none / 0) (#20)
    by Warren Terrer on Wed Jul 27, 2011 at 01:17:18 PM EST
    involuntarily default on foreign currency denominated debt, absolutely. That happened to Argentina about 10 years ago, and it seems to be what is going to happen to Greece. The United States doesn't have any foreign denominated debt, however.

    A monetarily sovereign country could default on its debt voluntarily, but I only know of one instance where that happened, namely Russia in the early 1990s, because it didn't have a clue about how capitalism and bond markets worked and was given bad advice by neoliberals. This kind of default is so rare and so completely arbitrary and pointless, that it's never been worth worrying about in any civilized country. Perhaps that will change thanks to the Tea Party.


    "Civilized Country"? (none / 0) (#37)
    by coast on Wed Jul 27, 2011 at 02:32:30 PM EST
    Not sure what your definition of civilized country is but given the fact that you can't through a dart at a world map and not hit a country that has not either defaulted or restructured their debt in some fashion in the last 30 years, save North America and parts of Western Europe, I would say that is a fairly narrow view.

    You are confusing (none / 0) (#41)
    by Warren Terrer on Wed Jul 27, 2011 at 03:02:35 PM EST
    foreign denominated debt with debts denominated in a country's own currency. Russia is the only country with its own currency afaik that defaulted on debt issued in that currency.

    I'm reasonably sure that all defaults you refer to were on debts denominated in foreign currencies. You don't have to agree with me, but I'd like to see specific examples please.


    I meant (none / 0) (#16)
    by Warren Terrer on Wed Jul 27, 2011 at 12:57:43 PM EST
    to include this link as well.

    Thanks, Warren (5.00 / 1) (#17)
    by jeffinalabama on Wed Jul 27, 2011 at 01:04:20 PM EST
    I think no one seems to pay attention to S&P (none / 0) (#12)
    by me only on Wed Jul 27, 2011 at 12:35:27 PM EST

    Institutional investors are required to comply with their prospectus.  So a downgrade could affect their ability to purchase (/hold?) the bond.

    I don't know if there is a significant difference between AAA and AA+, but when you cross the line to "B" there is a rather large difference.

    Without being able (none / 0) (#31)
    by CoralGables on Wed Jul 27, 2011 at 01:52:03 PM EST
    to provide a link as to not knowing where I read it in recent days, a downgrade by one of the rating agencies could cost the country about $100 billion a year in added borrowing costs.

    Interestingly, the Boehner plan would supposedly cost us the AAA rating, and thus cost more in long term interest than the Boehner plan is projected to save in cuts.

    Pardon my vast, willful, and blissful (none / 0) (#35)
    by kdog on Wed Jul 27, 2011 at 02:19:08 PM EST
    ignorance, but who signs any kind of loan/bond/financialmacallit deal that can swing 100 billion on a third party opinion whim?  Isn't that insanely stupid?

    Riiiight. Ask Greece. And ask the Germans (none / 0) (#39)
    by scribe on Wed Jul 27, 2011 at 02:59:40 PM EST
    because their 8 pm (their time) news led with the report that S&P has announced they are degrading (oops, meant "downgrading") Greece's sovereign debt to a "highly speculative" rating.  Moreover, they are not predicting, but also not ruling out, further downgrades in the future.  And they are also predicting a partial "selective repayment" of that debt, i.e., partial default (not that any default can be "partial" because it's a binary thing).

    Watch what happens now.

    Greece and Germany (5.00 / 0) (#42)
    by Warren Terrer on Wed Jul 27, 2011 at 03:07:44 PM EST
    use the euro. Neither Greece nor Germany are sovereign in their own currencies. Hence they DO have a risk of default on their euro-denominated debts. The United States, as the monopoly issuer of its own currency, the US Dollar, does not have a default risk on debts denominated in USDs.

    Riiight (5.00 / 0) (#43)
    by Big Tent Democrat on Wed Jul 27, 2011 at 03:14:24 PM EST
    Greece's problem is S&P. Riiiiiight.

    The point I was making (none / 0) (#44)
    by scribe on Wed Jul 27, 2011 at 04:44:41 PM EST
    was that people do listen to what S&P says.

    That the Greeks might default - in whole or part - is worrying to the Germans for lots of reasons, not the least of which is that the Germans are holding a lot of that Greek paper, formerly expecting and now hoping to be repaid.