When Standard and Poor’s announced its dreaded downgrade of U.S. Treasury bonds from their traditional AAA status last Friday, perhaps all the investors, legislators and citizens who trembled ought to have laughed instead. Perhaps they should ask whether S&P, as one of the handful of ratings agencies whose dubious conduct spurred the financial crisis, might still esteem Uncle Sam’s credit if only the Treasury doled out enormous fees to the agencies for those ratings – just like the bankers whose junk securities they had deemed impeccably AAA paid for those ratings.
Indeed, it seems reasonable to wonder if the weekend threat by top S&P executives to further downgrade government bonds is actually a solicitation for the same lucrative fees that bankers paid for those false stamps of approval on their mortgage-backed securities back before the housing bubble exploded. A famous old New York politician once disparaged the practice of law as an exercise in “learning how to call a bribe a fee” — a description that might well apply to the ratings business during the years leading up to the crisis.
Does the government need to pay the ratings agencies to recover AAA ratings for its bonds? Or is it time to simply disregard their ratings, as the legendary investor Warren Buffett yesterday said that he does?
Recent investigations by the Financial Crisis Inquiry Commission and the Senate Permanent Subcommittee on Investigations have raised fundamental questions about why and whether anyone still retains confidence in the opinions issued by S&P and Moody’s. To say that their sterling ratings of credit default obligations and other exotic mortgage-based loans were “inaccurate” is far too polite, particularly because the profits and stock prices of the ratings firms depended so heavily on the fees they earned from the investment banks whose securities they graded.
The Financial Crisis Inquiry Commission’s final report succinctly states the basic facts: “The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval…Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms.” Former FCIC commission member Byron Georgiou, now running for the US Senate from Nevada, says he was “incredulous” when he learned of the S&P downgrade, noting acidly how the ratings agencies fattened themselves on payments from the same Wall Street banks that issued the worthless securities they had repeatedly endorsed.
Echoing the FCIC report, the Senate subcommittee found that both S&P and Moody’s knew as early as 2006 that sub-prime mortgages were extremely risky, but continued to issue “investment-grade ratings” on securities based on those mortgages for several months. The subcommittee sharply criticized the “issuer pays” model used by the ratings agencies, the foundation of their unsound relationships with Wall Street companies and their feckless endorsements of products that led to the crash.
As Nomi Prins explained in the Daily Beast, there is deep irony and awful hypocrisy in the S&P downgrade if only because the nation’s worsening fiscal problems resulted directly from the ratings agencies’ own behavior. Moreover, those agencies have yet another conflict of interest in their confrontation with the federal government, whose regulators are supposed to police the future activities of the ratings agencies to ensure that they don’t repeat their past misdeeds.
But the credibility of the credit raters may at long last be suffering the same fate that they have sought to inflict on the United States. In a Saturday interview with Bloomberg Television, financial icon Buffett, the chairman of Berkshire Hathaway Corporation, said he disagrees with the downgrade. The United States deserves a “quadruple A” rating, he told Bloomberg correspondent Betty Liu. Moreover, although Berkshire is the biggest shareholder in Moody’s Corp., he told Liu that he doesn’t bother to consult the views of ratings firms when trading securities.
Nor for that matter will the S&P downgrade affect investment decisions at Western Asset Management, the Legg Mason Inc. division that oversees $365 billion in financial assets. The firm’s chief investment officer, Stephen Walsh, told Bloomberg: “Our money funds are required to invest in securities with the full faith and credit of the U.S. government, but it doesn’t speak to a rating. Our conversations with central banks and foreign investors show that they won’t view Treasuries differently [despite the downgrade].”
So Standard’s poor rating ultimately may not make the sky fall after all – and the government won’t have to cough up a billion-dollar fee to persuade them that their own country is still a creditworthy institution.