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While I do not agree with the decision by S&P to lower the credit rating of the U.S. government from AAA to AA+, I think they should be commended for sticking by a difficult decision despite what must have been enormous pressure. There is little doubt that phone calls from Washington were made by the likes of Tim Geithner and Ben Bernanke, and perhaps someday we will be privy to know exactly what was said when one of them writes his memoirs. But even more interesting to hear would be the supplicatory calls that S&P received from the titans of Wall Street such as Lloyd Blankfein, Jamie Dimon, and John Mack because all of their companies have very large holdings in Treasury bonds which were purchased with money borrowed from the Federal Reserve at no interest, and they rely on these bonds to provide them with guaranteed income, courtesy of the U.S. taxpayers. This is the back-door bailout that has unfortunately been eclipsed by TARP; now these Too-Big-to-Fail institutions will have to take a hit to their balance sheet (along with the rest of us), thanks to the analyst wonks at S&P.
I could not help but think about a line from Michael Lewis’s book, The Big Short. In describing how firms like Goldman conned the rating agencies into stamping their garbage CDO’s with AAA ratings, Lewis quotes a Goldman Sachs trader-turned-hedge fund manager, “Guys who can’t get a job on Wall Street get a job at Moody’s.” Even less flattering was the characterization by a Morgan Stanley quant of the rating agency staffs as “basically brain-dead”. Lewis summarizes the extreme mismatch:
“Wall Street bond trading desks, staffed by people making seven figures a year, set out to coax from the brain-dead guys making high five figures the highest possible ratings for the worst possible loans. They performed the task with Ivy League thoroughness and efficiency.”
How delicious it must have felt for the folks at S&P to have these same people groveling. I am willing to give S&P the benefit of the doubt by saying that they have fully realized that they were played like a Stradivarius by the sharpies of Wall Street and they have perhaps resolved to never let it happen again. Of course, this resolution will not be meaningful until the perverse incentive of the sell side paying for ratings is terminated.
As I said above, I do not agree with S&P’s downgrade decision because it puts them in the odd position of saying that four companies and several municipalities now have a higher credit rating than the federal government which has both confiscatory power (taxation) as well as the ability to decree cash into existence (quantitative easing). If Uncle Sam will see an increase in his cost of capital on Monday, then it is a near certainty that everyone else (i.e., companies, municipalities and individual borrowers) will suffer an increase as well. A better way for S&P to have framed this would have been the simple elimination of the AAA-category for all dollar-denominated debt because of the real possibility that the dollars the creditors will be repaid with will have much less purchasing power than they originally anticipated.
