Monday, March 15, 2010

Moody's Sovereign Debt Assurances Should Concern Investors

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

According to ratings agency Moody's, credit ratings of the world's four largest Aaa-rated sovereign nations - the U.S., UK, Germany and France - are currently "well positioned despite their stretched finances". The agency does however admit that risks have grown. Based on Moody's past actions, this should give investors little comfort.

In the current Greek debt crisis, Moody's was behind S&P and Fitch in downgrading Greek government debt. As reported in the Wall Street Journal, it took Moody's until December 23rd to make a downgrade of just one notch from A1 to A2. After the elections on October 4th, the Greek government admitted it had lied about its budget deficit and its ratio to GDP would be 12.7%, several times higher than previously reported. Even though the original numbers from the Greek government should have seemed unbelievably rosy, this apparently didn't make the rating's agencies suspicious. Are they likely to be more suspicious of the numbers generated by the politically powerful major countries that get their top ratings?

Prior to the Greek crisis, there was Iceland. According to the Central Bank of Iceland's website, Moody's downgraded Iceland's long-term debt obligations in domestic and foreign currency to A1 (still well within the investment grade range) on October 8, 2008. This was the same day that the Iceland's krona peg to the euro collapsed. Iceland had already nationalized major banks Glitnir and Landsbanki the month before. The Iceland prime minister had stated on October 6th that there had been a real danger of national bankruptcy. That scenario would have justified a rating of C from Moody's, many notches below the October 8th rating.

Investors should also not forget the role of the rating's agencies in giving securitized sub-prime loans top triple A ratings (Aaa in the case of Moody's). Moody's had to downgrade more than 5000 mortgage securities in 2007. The ratings agencies in general blamed mortgage holders that turned out to be 'deadbeats' and not their own practices. They would like us to believe that it was unreasonable for them to have assumed that people with spotty employment, a history of not paying their bills, and who bought houses they couldn't afford would default on their mortgages. If the rating agencies can ignore those problems, investors should ask themselves what problems they are ignoring with U.S., UK, German and French government financing?

How did the rating's agencies do with problem companies? Moody's downgraded Bear Stearns to Baa1 from A2 on March 14th, 2008. The Baa1 rating is an investment grade rating for Moody's (there are five speculative rating's below that level). That downgrade took place on the last day that Bear Stearns' stock traded. Moody's was still maintaining it was an investment quality company. The rating agencies did a little better with Enron, downgrading it to below investment grade four days before it declared bankruptcy. The stock had already lost almost all of its value before the downgrades, so the move was too little too late.

In its current analysis of sovereign finances, Moody's maintains that the major countries will be able to maintain fiscal stability because interest payments are reasonable compared to government revenues. However, government debts are increasing rapidly because of weak economies. If the global economy continues to stay weak, interest payments will go higher , tax receipts lower and debt will continue to pile up. Recovery, on the other hand, will raise interest rates substantially and this could overwhelm tax receipts and create a major debt spiral. The rating agencies are unlikely to consider that the major countries are caught in a lose/lose situation though since they seem to reserve their most speculative ratings for basic logic and common sense.

Disclosure: None

NEXT: The CFTC and Manipulation of the Silver Market

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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