Though Cowards Flinch

As I said in the previous post of this collection of three on credit rating, I couldn’t get hold of the full report from Moody’s report issued yesterday (‘Aaa Sovereign Monitor: major challenges still face the eight Aaa-rated sovereigns‘.  I’m asking Moody’s why, as I think that not making it available free of charge may be in breach of Moody’s own Code of Conduct.

What follows, therefore, is based on Moody’s Code of Conduct, which is freely available on its website, and on reports in the free financial press on what Moody’s Head of Sovereign Risk, Pierre Cailleteau had to say in the above-mentioned report. 

The initial question for this post is how far what Pierre Cailletaeu said in keeping with his on company’s Code of Conduct:

This is what the Code of Conduct says credit ratings are, and are not:

Credit Ratings are MIS’s current opinions of the relative future credit risk of entities, credit commitments, or debt or debt-like securities. MIS defines credit risk as the risk that an entity may not meet its contractual, financial obligations as they come due and any estimated financial loss in the event of default. Credit Ratings do not address any other risk, including but not limited to: liquidity risk, market value risk, or price volatility. Credit Ratings are not statements of current or historical fact. Credit Ratings do not constitute investment or financial advice, and Credit Ratings are not recommendations to purchase, sell, or hold particular securities. Credit Ratings do not comment on the suitability of an investment for any particular investor.

This is what  Marketwatch had to say about Pierre Cailleteau’s report on why some Aaa countries, including the UK, are being rated, within that Aaa status, as ‘resistant’:

“Resistant” countries, such as Canada, Germany and France, were weakened by the crisis but started from strong fiscal positions. They don’t face a lasting challenge to their economic model or a “massive risk of crystallization of contingent liabilities,” the report said.

“While resistant, they are clearly not immune,” Cailleteau said. “Debt may increase, but not to the extent of stretching affordability beyond a level consistent with a Aaa status.”

………………………..

Britain’s gross debt to GDP ratio is forecast to rise to 69% at the end of 2009 from 47% in 2007. The ratio of U.S. debt to GDP rose to 53.5% from 40.2% a year earlier, Moody’s noted, but also highlighted that the ratio of interest payments to government revenue declined to 8.4% from 10% despite a sharp rise in debt outstanding.

That is a clear indication “U.S. debt “financeability” is strong,” Moody’s said. The agency said that by its measure, U.S. debt financeability is the strongest of any country.

Cailleteau said Britain’s classification as a “resilient” Aaa issuer was backed by a high degree of debt financeability and “an equally high assessment of debt reversibility.”

Now, there are two key terms in play here: ‘affordability’ and ‘financeabilty’. 

Affordability seems fairly straightforward, and is a question of whether the debt can be paid back.

As such, it looks perfectly in order for MIS to make an assessment of ‘affordability’, and in keeping with the Code of Conduct’s wording on what credit rating is all about:

MIS defines credit risk as the risk that an entity may not meet its contractual, financial obligations as they come due and any estimated financial loss in the event of default.

But the neologism ‘financeability’ is different.

It’s not a synonym for ‘affordability’, not least because it is juxtaposed with the assessment of “debt reversibility”, which is in fact another way of saying ‘affordability’. In any event, why would a senior figure, in an important and widely read report, choose to use a made up word if the word afffordability is just as good?

No, “financeablity” means something else here. It refers, I suggest, not to whether countries can pay back debt, but whether the market will keep on loaning to them on terms which are then affordable.

And herein lies the problem.

Quite simply, assessing whether ‘the market’ will continue to finance Aaa countries lies outside the remit of Moody’s, as set out in its own Code of Conduct.

This is not just a semantic distinction. 

Moody’s, and the whole of the credit ratings industry’s, professed raison d’etre is to provide ‘objective’ and ‘transparent’ assessments on whether loans can be repaid, not to reflect the view of the market on whether loan issues will be bought.

If credit rating agencies are doing the latter, then they are simply there to reinforce and provide institutional legitimacy to emerging ‘market positions’.

Of course we know the credit rating agencies act in cohort with, rather than independently of, investors at a private debt issue level; that’s how the asset bubble of the mid 2000 was created, and what Giles’ recent post is all about. But what is important here is that the head of Sovereign Risk at Moody’s is effectively saying it’s happening at the level of the national economy level too.

And that is why these new categories of ‘vulnerable’, ‘resistant’ and resilient’ have been created within the overall Aaa category.

For the big financial institutions, it is simply unthinkable that the US economy, whatever the size of its debt and however ‘unaffordable’ it becomes, will lose its triple Aaa status, and placing it neatly in the middle category (along with the UK) sends out the right signal about the need for what the MIS report refers to as “apparent consensus among the public” in favor of fiscal retrenchment, including spending cuts.

At the same time, though, it still provides freedom to move the US into ‘Aaa vulnerable’ if need be, at which point a new sub-category of high, medium and low vulnerabilty may suddenly appear.

That is to say: credit ratings of sovereign risk are nothing to do with objective risk assessment, and all to do with asymmetric power of the big world economies.

The US, and to a lesser but still significant extent the UK, is where the institutional power of capitalism lies, and the credit agencies will do the bidding of those who have their power bases there.

Greece is less fortunate. So is Ireland. These economies, and the people who depend on them are small and insignficant enough to be disposable. Their ratings have been cut ‘pour encourager les autres‘.

In Greece’s case, it’s also a signal that worker unrest will really just not do. As Stephanie Flanders notes in this excellent post on the downgrading of Greece and the ‘end of bailouts’ by the ECB to the weaker European economies:

Fitch, the ratings agency, would say that its decision to downgrade Greek sovereign debt had nothing to do with events in Dubai. But ever since the Dubai World story broke, investors – and ratings agencies – have been taking a fresh look at the indebted countries on Europe’s periphery, wondering whether any of these countries will be next.

Greece isn’t the only country which would rather not have the extra attention. There’s plenty for the likes of Latvia and Ireland to worry about as well, and a sombre warning for the UK, too – though, as Moody’s made clear in its sombre assessment today, Britain is still a very long way from being Greece.

In the end, these countries are afforded no choice in the way they deal with their economic problems. The door on credit is being closed, not for reasons of ‘affordability’ – after all, they could grow their way out of debt with well-directed investment – but because the markets have decided they are no longer ‘financeable’, and have instructed the credit rating industry accordingly.

This is in spite of well-informed opinion even from within banking that such savage cuts will hurt economies in the longer term; the important thing is not the health of these small economies, and the well-being of their people, but to enforce the rules of fiscal probity on small countries in the interests of continued control of the financial system in the big ones.

Yesterday, Giles quoted something I said in an earlier post about credit ratings, in which I attacked the myth that:

S&P are anything other than a corrupt part of a corrupt system, and reinforces my view that they are a legitimate and strategically useful target for anti-capitalist political action, direct and indirect.

I stand by that contention, not just in respect of Standard and Poor’s (S&P) but the whole of the credit rating industry. Its codes of conduct professing objectivity and transparency may be well and persuasively written, but they are not worth the paper they are written on.