Last week, Moody's -- the ratings service that played a central role in the financial crisis, the results of which remain painfully alive -- threatened to downgrade America's credit rating.
Here's what they said in their press release:
... if there is no progress on increasing the statutory debt limit in coming weeks, {they} expect to place the US government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default.If the debt limit is raised and default avoided, the Aaa rating will be maintained.
However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating.
So here's the thing. (One of President Obama's favorite locutionary preambles.) Should Moody's be in the business of prospectively rating sovereign debt based on whether or not a government takes certain steps? Do they have the financial credibility and morality authority to do that? Should they be reacting to the current situation or should they be theorizing about a complex and variable collection of uncertainties in the future?
This is not an insignificant distinction. Moody's exists for a very simple reason: to provide dispassionate analysis -- resulting in a grade -- that allows potential investors to determine whether or not a particular debt instrument can be trusted, and through that, how it should be priced.
But by wading into the debt reduction battle, Moody's is no longer an entity that analyzes credit risk in the present tense. It becomes an entity that attempts to influence and shape policy. Should a for-profit, public company be threatening the government by saying do this or else? Highly doubtful.
Further, why would anyone trust Moody's about delayed risk when they were so brain-dead when it came to assessing immediate risk? Let's not forget the billions of blithely over-rated CDOs and other instruments in the long and frothy run-up to the sub-prime crisis. As Phil Angelides, who ran the Financial Crisis Inquiry Commission bluntly put it:
They {Moody's}were huge enablers of these toxic mortgage securities... they failed miserably. They approved fraudulent products. This is as if UL (electronics testing firm) was testing toasters, and 90% of them blew up in your kitchen.
The profound structural flaw in Moody's business -- and this is no secret -- is that they are paid by the very issuers they are supposed to weigh in on, objectively. ProPublica neatly summarizes the stunning problem:
The ability for bankers to run the show has long been an obvious flaw in the ratings system for structured products. Investment banks create the securities and benefit when they receive generous ratings. Banks pay the agencies that supply the ratings. Yet the agencies are somehow supposed to hold the line with the people who are responsible for their paychecks.
This was supposed to be fixed by Dodd-Frank. But it hasn't. ProPublica goes on to point out that:
Since {the melt-down} the government has tried to change the ratings agencies. The Dodd-Frank financial reform law has some bold measures, like making the ratings firms liable for their judgments. Unfortunately, the rules are in danger of not being enforced because of budget constraints and resistance from the agencies.
So here we have Moody's continuing to be the same wealthy fox guarding the same complicit hen house. But that doesn't stop it from lecturing the Fed about its own borrowing habits.
I think are two very strategic reasons behind Moody's well-publicized warning last week. The first is PR spin. They want to be seen not just as thought-leaders, but as advocates of fiscal prudence. Leave the past behind by identifying yourself with a conservative view of debt, even though you made millions for yourselves and the banks by expunging "default" from your spell check, and tossing caution to the winds.
Moody's should not be attempting to influence fiscal policy here -- or anywhere else (including Japan, while they are similarly trying to browbeat the government) -- with the specter of ratings punishment.
The second reason that Moody's inserted itself in the debt ceiling debate is that they sell research on sovereign debt, so the fact that they were able to send the markets into a tailspin with their comments about U.S. debt becomes a branding statement about their global power.
Here's how their marketing materials pitch their expertise:
Moody's rates over 450 sovereigns and sub-sovereigns around the world... Our Sovereign specialists work closely with economists, bank analysts, legal, accounting, and regulatory specialists to clarify the real risks of sovereign securities and to equip you with the information to identify value.
What a lovely ecosystem for them. Moody's issues a press release that warns the U.S. is potentially headed for a downgrade. The media jump all over it, and their name gets associated with fiscal prudence. (Meanwhile, they are still being compensated by banks in the old exploding toaster model.) At the same time, their salespeople fan out all over the world and sell their sovereign debt research, using their PR release on U.S. fiscal policy as exemplary of their expertise and influence. And "objectivity."
This week, a report found that around 40% of all those who took out second mortgages are now underwater with their houses. Of course, Moody's rated millions of those bundled mortgage instruments as investment grade.
Now, the same people who paid no attention to the quality of the underlying mortgages are attempting to re-brand themselves as fiscal Puritans by threatening to downgrade U.S. debt. And they'll make money from that in the process. Is there any wonder that our trust is under water?