For starters, I seem to find myself agreeing with Paul Krugman here: Credibility, Chutzpah and Debt. Well, except that it may not be as easy as he imagines to implement a sustainable fiscal policy, and I disagree with his laying the entire blame on an "extremist right." But what he says about the major ratings agencies may largely be true. Not that I can tell for sure...I am no expert in rating bonds. I'm not even sure about this claim (that I've heard repeated elsewhere):
And S&P, along with its sister rating agencies, played a major role in causing that crisis, by giving AAA ratings to mortgage-backed assets that have since turned into toxic waste.
I would very much like to know how many AAA rated MBS actually did turn toxic. Does anybody know? (Please send data, or links to estimates.)
I ask this because to some extent, I think that the bond rating agencies sometimes get a raw deal from public perception. It is my understanding (and I reiterate that I'm no expert) that what is being rated is the prospect of default on a set of debt covenants. While it may be true that MBS was treated as "toxic" by market participants (repo) during the crisis, this was more a "liquidity" event (perhaps based on the fear that some MBS were toxic, but not knowing the identity of which). As far as I can tell, bond ratings are not meant to capture liquidity risk. And perhaps most of that MBS continued to generate income. I'm just not sure how much of it did.
In any case, this takes me to the issue of the recent S&P downgrade of "long term" U.S. debt. The S&P statement can be found here.
Gosh, on the surface, the downgrade seems to be crazy. That is, the prospect of a nominal default seems remote; a real default (via surprise inflation) seems much more likely (though, this is not what is being rated). On the other hand, this is what a friend of mine had to say on the matter:
These ratings are educated opinions about how likely it is that holders of US debt will get their money back (including the yield). A AAA rating means it is basically a sure thing. AA- means there are conceivable, albeit not terribly likely, circumstances under which the funds will not materialize. This is not a direct comment on politics or the various reasons this event might happen. There are various reasons, including continued high spending, insufficient tax revenue, too little growth for the economy to pay the required taxes,... These are all lumped together in determining the rating. Of course, political types wish to point to their favorite reason, whether it is Democratic spending or Tea Party opposition to taxes. But don't let this confuse you. The point is simply that there is so much debt -- and it's growing -- that there is now real uncertainty about whether it can/will ever be paid.
What I find most interesting is the market reaction to recent events. First, I guess it's not too surprising to see how the price of gold has behaved recently; it has surged upward.
The "curiouser" part, however, is with respect to how the price of long-term U.S. debt has behaved. Here is a plot the price of Barcley's 20+ year U.S. bond fund.
Whoa! How do we make sense of the joint upward movement in the price of gold and (future) U.S. money; especially as the latter has just been downgraded?
The behavior of U.S. debt over the last few years has really intrigued me. Yes, the U.S. has a huge amount of outstanding debt out there. But you know what? The rest of the world seems to want it. Despite some bluster out there about replacing the USD (and US Treasuries) as the world reserve currency, I just don't see this happening any time soon. I know that a lot of people would like to see this happen. Might want to be careful what we wish for out there!
I ask this because to some extent, I think that the bond rating agencies sometimes get a raw deal from public perception. It is my understanding (and I reiterate that I'm no expert) that what is being rated is the prospect of default on a set of debt covenants. While it may be true that MBS was treated as "toxic" by market participants (repo) during the crisis, this was more a "liquidity" event (perhaps based on the fear that some MBS were toxic, but not knowing the identity of which). As far as I can tell, bond ratings are not meant to capture liquidity risk. And perhaps most of that MBS continued to generate income. I'm just not sure how much of it did.
In any case, this takes me to the issue of the recent S&P downgrade of "long term" U.S. debt. The S&P statement can be found here.
Gosh, on the surface, the downgrade seems to be crazy. That is, the prospect of a nominal default seems remote; a real default (via surprise inflation) seems much more likely (though, this is not what is being rated). On the other hand, this is what a friend of mine had to say on the matter:
These ratings are educated opinions about how likely it is that holders of US debt will get their money back (including the yield). A AAA rating means it is basically a sure thing. AA- means there are conceivable, albeit not terribly likely, circumstances under which the funds will not materialize. This is not a direct comment on politics or the various reasons this event might happen. There are various reasons, including continued high spending, insufficient tax revenue, too little growth for the economy to pay the required taxes,... These are all lumped together in determining the rating. Of course, political types wish to point to their favorite reason, whether it is Democratic spending or Tea Party opposition to taxes. But don't let this confuse you. The point is simply that there is so much debt -- and it's growing -- that there is now real uncertainty about whether it can/will ever be paid.
What I find most interesting is the market reaction to recent events. First, I guess it's not too surprising to see how the price of gold has behaved recently; it has surged upward.
The behavior of U.S. debt over the last few years has really intrigued me. Yes, the U.S. has a huge amount of outstanding debt out there. But you know what? The rest of the world seems to want it. Despite some bluster out there about replacing the USD (and US Treasuries) as the world reserve currency, I just don't see this happening any time soon. I know that a lot of people would like to see this happen. Might want to be careful what we wish for out there!
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