The debate over raising the U.S. debt limit put Standard & Poor’s, the world’s biggest provider of credit ratings, and its competitors in an awkward spot: judging the creditworthiness of the U.S. government at the same time that Congress considers rules to limit their power.
“This is the definition of a rock and a hard place,” says Peter Appert, an analyst at Piper Jaffray & Co. in San Francisco. “There’s no upside for the rating agencies in this debacle.”
Congress and federal regulators are discussing ways to implement the Dodd-Frank Act, which contains provisions aimed at reducing the raters’ role in the financial system and creating more competition in an industry dominated by S&P, Moody’s Investors Service and Fitch Ratings. In an April report, a Senate panel blamed raters for fueling the financial crisis, saying they engaged in a “race to the bottom” to stamp inflated grades on mortgage-backed securities.
Washington is now watching as the ratings companies mull whether to lower the nation’s grade, Bloomberg Businessweek reports in its Aug. 8 edition. S&P is considering striping the U.S. of its AAA rating even after Congress agreed to lift the debt limit. The country’s debt to gross domestic product ratio is nearing 75 percent, putting it on a worse track than top-rated France and Germany, the company said in a July 14 statement.
“We suspect they’re under tremendous pressure not to downgrade,” Mohamed El-Erian, chief executive of Pacific Investment Management Co., the world’s biggest manager of bond funds, said in an Aug. 3 interview on Bloomberg Television’s “In the Loop” with Betty Liu. “But if they stick to what they told the world on July 14, they will downgrade.”
Moody’s, the second-biggest rater, and Fitch, No. 3, affirmed their AAA ratings after Congress reached the debt deal while warning that downgrades are still possible if lawmakers fail to enact further debt reduction measures or the economy weakens.
“We have the people who helped cause the financial crisis now claiming that they’re experts on what the American budget should be,” Representative Barney Frank, a Massachusetts Democrat, said in a telephone interview.
The Dodd-Frank law, passed last year, directs bank regulators such as the Federal Reserve to avoid using credit ratings in making rules such as bank capital requirements. Regulators have yet to comply with that provision, in part because they are searching for an alternative way to judge bonds.
Called to Congress
When Congress summoned S&P President Deven Sharma to a hearing on July 27 to discuss ways to implement Dodd-Frank, politicians also questioned him about his analysts’ warnings on the U.S. credit rating.
“Do you honestly believe that the United States could default on its debt?” Representative Francisco Canseco, a Texas Republican, asked Sharma.
“Our analysts don’t believe they would,” Sharma replied. “Changing a rating doesn’t mean it would default. AAA, all it means is that it is a low probability, a very low probability, of a default.”
Ratings companies are “well aware of the power that politicians have” over them, Christian Opp, a professor at the University of Pennsylvania’s Wharton School, said in a telephone interview.
Moody’s paid Akin Gump Strauss Hauer & Feld $610,000 this year to lobby Congress on financial regulation, according to disclosure forms filed with the Senate, while S&P’s parent McGraw-Hill Cos. paid Podesta Group $240,000.
Last month, a House panel passed a measure to repeal a part of Dodd-Frank that would make raters liable if they award a high grade to securities that turn out to be risky. The Securities and Exchange Commission is considering the feasibility of a Dodd-Frank rule written by Senator Al Franken, a Democrat from Minnesota, that would set up a board with the power to assign raters to some bond issues, giving an opportunity for smaller companies to get more assignments.
At the same time, the government has been pressing its case to retain the AAA rating. Treasury Secretary Timothy Geithner and Jacob Lew, director of the White House Office of Management and Budget, met with John Chambers, chairman of S&P’s sovereign rating committee, and other S&P analysts on Apr. 13 to discuss the administration’s fiscal-reform plan and the odds of it passing, Geithner told Congress in a letter.
“It’s one thing for them to be lobbied by General Electric,” said Peter Morici, a professor of business at the University of Maryland. “It’s another thing to be lobbied by your government.”
S&P’s analysts are separated from its lobbyists and salespeople by a “strict firewall,” said Patti Rockenwagner, a spokeswoman for the New York-based company. She declined to comment on any conversations the company may have had with government representatives since April.
Mary Miller, assistant Treasury secretary for financial markets, said at a news conference on Aug. 3 that the Treasury doesn’t solicit the ratings and has made officials “available to answer any questions about the legislation as we would in just the normal course of events.”
In Europe, politicians raised the specter of retaliation when ratings companies withheld their approval of plans to rescue Greece, Portugal, and Ireland. After Moody’s cut Portugal’s rating to junk on July 5, German Finance Minister Wolfgang Schaeuble said there’s a need to “break up” the big raters’ dominance.
The raters retain their role as gatekeepers in the bond market. About two-thirds of the biggest pension funds require that any bonds they buy have ratings from S&P, Moody’s, or Fitch, according to Kroll Bond Ratings Inc., a competing firm that issued its first assessments this year.
Bloomberg LP, owner of Bloomberg Businessweek and Bloomberg News, also started providing its own credit ratings last year.
Moody’s revenue from rating corporate bonds rose to a record $563.9 million last year, according to data compiled by Bloomberg. S&P doesn’t break out similar figures.
“We didn’t go as far away from the rating agency model as people expected,” Jeff Matthews, author of “Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett,” said in a telephone interview. Buffett owns 12.4 percent of Moody’s, Bloomberg data show. “Not only are companies dependent on them, but now countries are too.”