By JACK HOUGH
To hear politicians, the fate of modern finance is now being decided by perhaps a dozen Manhattan bond geeks. Their job at Standard & Poor's and Moody's is to paste letter grades on governments so bond buyers can decide which are good for the money. Even America's president fears them. "A six-month extension of the debt ceiling might not be enough to avoid a credit downgrade," he warned the nation in an address Monday night, having already listed some of the consequences: "Interest rates would skyrocket on credit cards, on mortgages and on car loans."
Given that Treasury bonds have historically served as a benchmark against which the safety of other investments is judged, the spillover effects would be "extremely damaging" for the world economy, a senior advisor for the International Monetary Fund said this week.
Someone forgot to tell the investors who stake actual money in Treasury bonds, however. The closely watched 10-year Treasury has gained since the beginning of the year, dropping its yield from 3.4% to 3.0%. That means interest rates on the things the president mentioned aren't expected to "skyrocket" soon--not even if the rocket he had in mind is only one of those backyard balsa-wood-and-gunpowder fliers.
Maybe financial markets are waiting for the actual downgrades. But that would contradict an investment law as basic as gravity: Markets are forward-looking. At any given moment, they anticipate information that's known or even suspected. S&P announced a negative outlook on the U.S. (warning of a possible downgrade) in April, and Moody's announced something similar earlier this month. By now, anything that would have happened has happened.
It's not that investors doubt the judgment of raters, although the latter have attracted plenty of jeers in recent years, partly because their pay-me-to-rate-you business models are inherently awkward, and partly because they have missed some colossal collapses. Enron had an investment-grade credit rating four days before it went bankrupt. During the recent housing bust, mortgage securities that were sold as Parmigiano-Reggiano turned out to be a notch below Cheez Whiz. That has led some outside analysts to mutiny. In December, Meredith Whitney, who made her name covering banks, told CBS's "60 Minutes" that 50 to 100 "sizeable" municipalities could default on amounts totaling "hundreds of billions of dollars," directly contradicting the ratings agencies, who expect that municipal defaults will be isolated and manageable.
The Living Yield Curve
Where will the debt-ceiling debate take the Treasury yield curve?
So far, the ratings agencies have been right on municipalities. I suspect that they've taken recent criticism to heart and are working hard to produce good research. And in fairness, creditworthiness is a complicated thing to judge, depending as it does on human behavior, and the agencies get plenty of calls right. If they say the U.S. is bucking for a downgrade, I'll take their word for it. I'm unfashionably bullish on America, but I'm not sure anything deserves a perfect credit rating, least of all something that can make its own money.
But I also think the opinions of S&P and Moody's (and Fitch, which says it will decide its opinion of the U.S. in August) are irrelevant when it comes to Treasurys. These firms add value by tracking a universe of bond issuers too vast for most investors to watch. Their opinions on Ford Motor or the city of Rochester, N.Y., matter greatly to bond buyers.
The world doesn't need help analyzing Treasurys, though. No entity in the world is more closely watched than the United States government, not even Lady Gaga. And none publishes more and better information on its financial condition. The sort of investors who decide Treasury prices--foreign governments, giant mutual funds, the Social Security Trust Fund--don't wait for S&P or Moody's to tell them whether to buy. They do the math themselves.
They also have limited choices. In a recent report for Wells Fargo Securities, economist Jay Bryson writes that investors aren't likely to dump Treasurys, simply because Europe has no unified debt security and most Asian capital markets are small and illiquid, save for that of Japan, which is in worse shape than the U.S. What about the fear that large investment funds, bound by prospectus to buy only AAA-rated bonds, would be forced to sell? Bryson calls this "overblown" for two reasons. Mutual funds hold just 7% of Treasurys. Also, Bryson's team reviewed prospectuses for the largest ones and found no such mandate.
So fear the debt and the deficit a little and political intransigence a lot, but don't fear the alphabetical Armageddon of a dozen researchers swapping their As for Bs. I'm guessing about the number, by the way. None of the agencies would tell me how many analysts decide their U.S. rating or even how much of the decision is based on perceptions rather than numbers. A document provided by Fitch says its minimum committee size is generally four analysts including one "senior director," and that those average six to seven years of tenure. That's comforting. If I'm wrong, I'd hate for the world's financial system to be brought down by new hires.