In August of 2011, Standard & Poor’s Rating Services downgraded its long-term sovereign credit rating on the United States from ‘AAA’ to ‘AA+’ (from the highest possible rating to the second-highest) with a negative outlook. The firm wrote that the “downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.”
At the time, the U.S. was involved in a “prolonged controversy” over the debt ceiling. Just a few months before S&P issued the ratings change it looked like the nation was hurtling towards another government shutdown. As usual, budget negotiations soured with policymakers unable to reach a happy compromise and bad blood boiled on either side of the aisle.
“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed,” wrote S&P Ratings. “The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy.”
Two years later, as the nation once again stares the threat of a government shut down in the face, S&P’s comments seem particularly prescient. The U.S. has yet to receive another explicit downgrade to its long-term credit rating thanks to the current fiscal fiasco, but the negative outlook prescribed by S&P in 2011 does seem appropriate.
The credibility of ratings agencies has been called into question in the wake of the late-2000s financial crisis. Earlier this year, the U.S. Department of Justice actually filed a lawsuit against S&P Ratings alleging that the firm failed to accurately characterize the riskiness of certain securities — such as mortgage-backed securities or collateralized debt obligations, which were at the heart of the crisis — and artificially inflated its ratings in order to generate new business. (Part of the backwards arrangement of the ratings system is that it is often the case that the firms that are trying to sell the securities hire the ratings agencies, creating a pretty fundamental conflict of interest.)
Investors, too, have grown dubious of certain ratings firms. Just this week, PIMCO co-Founder and co-CIO Bill Gross, who manages the Total Return Fund and is considered one of the best bond investors on the planet, made reference to the trust issue in a tweet.
Gross may be referring to a rating action by Moody’s in July, when the firm affirmed an ‘Aaa’ (the highest possible) rating for long-term U.S. debt and upgraded its outlook from negative to stable. The firm wrote that the “action reflects Moody’s assessment that the federal government’s debt trajectory is on track to meet the criteria laid out in August 2011 for a return to a stable outlook, removing the downward pressure on the rating over Moody’s outlook period.”
Fitch Ratings also has a triple-A rating on the U.S., but maintains a negative outlook. Egan Jones, the other ratings agency mentioned by Gross, has a AA- rating on the U.S., the result of a downgrade from about this time last year when the last debt ceiling debate was getting rolling. The firm wrote in a note seen by MarketWatch that, “From 2006 to present, the US’s debt to GDP rose from 66 percent to 104 percent and will probably rise to 110 percent a year from today under current circumstances; the annual budget deficit is 8 percent.” (It’s worth pointing out that Egan Jones was recently barred from grading government debt and asset-backed securities for a period of 18 months by the Securities and Exchange Commission. Like S&P, the firm is accused of misstating the risks associated with certain securities leading up to the financial crisis.)
America’s ability to manage its debt is a critical component of its credit rating, and it appears based on Gross’s comment that he has a more negative outlook on the situation than positive. The distinction may seem superficial, but the difference between a ‘prime’ rating and a ‘high grade’ rating bears significance. The negative outlook is particularly unattractive to investors.