Rating the worth of the ratings agencies

Should Australians be worried by reports of a potential downgrade to the nation's prized AAA credit rating? Probably not.

Credit rating agency Standard and Poor’s has hinted that it might review Australia’s prized AAA credit rating if the Senate  fails to pass at least “some” of its $37 billion in planned savings, according to The Australian Financial Review.

The bond market reacted coolly to the news, with yields for both two-year and 10-year government bonds only nudging up slightly.  Should we be concerned about a potential downgrade of Australia’s gold-plated AAA credit rating?

In November 2013, when Standard and Poor’s downgraded France’s credit rating from AA to AA, the country’s 10-year borrowing costs went up only two basis point, or two-hundredths of a percentage point.  And France has a significantly higher debt-to-GDP ratio than Australia.

US 10-year Treasury yields were 2.55 per cent yesterday, one basis point lower from the 2.56 per cent they traded at on August 5, 2011, the day Standard and Poor’s stripped the country of its prized AAA rating.

Admittedly, the US is a special case and its Treasury bonds form the bedrock of international financial system with their unparalleled liquidity. Bond investors have little choice but to turn to the Treasury bonds.  But it seems even fiscally challenged France is able to shrug off a credit rating downgrade.

Investors have largely ignored such downgrades, reflecting a shift from reliance on ratings companies to a focus on in-house analysis, according to Bloomberg.  Indeed, the reputations of the big credit rating agencies have been battered after the global financial crisis.

Companies like Standard and Poor’s and Moody’s played a key role in the US subprime mortgage meltdown.  They stamped their seal of approval — AAA ratings — on mortgage-backed securities that turned out to be worthless.

After the crisis, the US Congress passed the Dodd-Frank Act that requires the Securities and Exchange Commission to hold credit rating agencies to the same standard of “expert liability” that auditors and lawyers face when they give opinions.  The SEC issued such a ruling four years ago, but credit rating agencies have threatened to withhold issuing assessments, to fend off the proposed regulatory change.

China’s central bank governor Zhou Xiao Chuan also urged Chinese companies recently not to rely on foreign credit agencies. “When a company runs into trouble, its credit rating will be ruthlessly downgraded. However, there are no insightful assessments before the problems happen. They only amplify the best and the worst of the subject of credit assessment and exacerbate the development of the crisis,” he reportedly said.  

The Chinese and American investors are not the only people irritated by the rating agencies. The European Commission was critical about the many failures of “Poor & Standards” since the start of the financial crisis -- from giving Lehman Brothers an A-rating just a month before it went bust to underestimating the euro zone’s determination to hold the disintegrating union together and to avoid a disastrous Greek exit.

The EU financial regulator even threatened the big three credit rating agencies with fines and withdrawal of licenses over their assessment of government bonds in December 2013.

Credit ratings are an important part of the financial system, helping investors to understand credit worthiness of companies, bonds and countries.  But faith in their ratings has been badly damaged after the financial crisis. Though it still matters, people are increasingly relying on their own judgement.

For what it’s worth, China’s leading credit rating agency Dagong International still thinks highly of Australia’s ability to services its debt.  This country is one of seven countries that enjoy the highest credit rating from Dagong.

The Chinese credit agency says that although Australia's external debt will continue to increase, the country's stable long-term economic growth and net capital flow will ensure Australia's ability to service its debt. 

It says through Australia’s external debt increases further and the risk of the external balance continues to accumulate, the stable economic development in the long term and net capital inflows will secure external debt solvency.

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