United States vs S&P: Sovereign Ratings Next?

♠ Posted by Emmanuel in , at 2/05/2013 03:07:00 PM
It is with great interest that I am following the ongoing civil suit by the United States against the rating agency Standard and Poor's. Awhile ago, Tim Sinclair over at Warwick University came out with a book entitled "The New Masters of Capital" describing how credit rating agencies supposedly had powers of nearly life and death on any number of countries and firms via the act of rating. I was not very receptive to this all-encompassing argument. First, the parent companies of S&P, Moodys and Fitch's have hardly outperformed broad market indices--which they would if they truly were "masters of capital." Second, while developing countries may be adversely affected by ratings decisions of these firms and affect their ability to access global capital markets, others are not so vulnerable. Japan and the US among others appear insensitive to credit downgrades. What's more, governments alike those in the US and Europe give them sanction to issue ratings in the first place. Think of America's SEC granting "Nationally Recognized Statistical Rating Organization" (NRSRO) status.

I believe my second argument is validated by the US declaring that it will file a civil suit against S&P causing its parent firm McGraw-Hill's stock to plunge in double-digit percentages. In other words, a true "master" would not be accountable to someone else:
The government said in a court filing it was seeking civil money penalties from S&P and McGraw Hill. "Considerations regarding fees, market share, profits, and relationships with issuers improperly influenced S&P's rating criteria and models," the government said.

Shares of McGraw-Hill plunged 13.8 percent on Monday after the company said it was expecting the lawsuit, marking their biggest one-day percentage decline since the 1987 stock market crash, according to Reuters data. The news also caused shares of Moody's Corp, whose Moody's Investors Service unit is S&P's main rival, to slide 10.7 percent.
I think it's evident where "power" lies here: the state with sanctioning power over credit rating agencies. The case mainly deals with conflict of interest in S&P being asked by various financial services concerns to rate mortgage-backed securities, collateralized debt obligations and what else have you for a fee. There was indeed some of that going on, but why now? Also, why S&P instead of the others alike Moodys and Fitch's? Some thoughts:
  1. Ratings on mortgage-related securities were vastly overstated; the question is whether these errors came from flawed models / judgement OR deliberately being paid to inflate credit ratings;
  2. This stuff is really old--2007 or 2008 vintage--so why is it only being prosecuted now?
  3. Why S&P in particular? It's the biggest rating agency yes, but was it really alone in issuing flawed ratings?
Being ever-so-cynical, I am thinking that this action may have something to do with forthcoming credit downgrades of US sovereign debt. Think about it: filing the case has already depressed their stock valuations and reminded them that government displeasure is costly. Moreover, Uncle Sam can readily shut them out of the business of rating a huge swathe of dollar-denominated securities if it revokes their NRSRO status. Revocation of NRSRO status would mean that they can no longer pass judgement on US Treasuries among other things:
Under the Credit Rating Agency Reform Act, an NRSRO may be registered with respect to up to five classes of credit ratings: (1) financial institutions, brokers, or dealers; (2) insurance companies; (3) corporate issuers; (4) issuers of asset-backed securities; and (5) issuers of government securities, municipal securities, or securities issued by a foreign government. 
The United States may be reiterating that it can easily put them out of business Stateside if it chooses to. Given America's runaway debt expansion, what better time is there of reminding them of this fact than now when eminently justified downgrades are on the horizon? Downgrades may not so adversely affect US borrowing costs in the near-term, but the loss of prestige may be enough to motivate America to take action now. New masters of capital? You must be joking. When the world's largest debtor has got the credit rating agencies by the balls in so stark a fashion, I think they're more like the jesters of capital.

Bottom line: The US economy may be a sick joke, but the official econocomedians still lord it over the jesters of capital as recent events have demonstrated. As for me, I'll do my own due diligence when investing in securities instead of believing in either Uncle Sam or his NRSRO flunkies--and you should too.