U.S. Credit-Rating Downgrade — Do Investors Really Care?
The news from Standard & Poor’s on Friday evening reverberated during the weekend in financial and political circles throughout the world. Having decided that insufficient progress had been made in righting the substance and process of U.S. fiscal health, the unthinkable happened, and a credit-rating downgrade was issued.
Except that it wasn’t all that unthinkable. S&P had telegraphed this move well in advance, a welcome change from the tendency of credit rating agencies to weigh in past the point where market participants had already accounted for changing circumstances. Investors had some time to think about the prospects for a downgrade and decide what action to take. Based on the CFA Institute Survey of members conducted on 29 July, 43 percent of respondents said they had no plans to reposition U.S. government securities holdings, with only 6 percent planning to buy or sell at that point and 14 percent having already taken action to buy or sell. In the same survey, 49 percent anticipated a moderate rise in yields for U.S. governments, with 31 percent predicting little effect on yields and only 15 percent expecting a sell-off that would raise yields significantly. Several survey respondents thought we should have included an option for yields to fall, perhaps in response to a flight to safety or unleashing of deflationary pressures in the global economy as borrowing costs increase. At least on Monday morning, with bonds trading up, those scenarios look credible.
The practical effect of one nationally recognized statistical rating organization (NRSRO in U.S. regulatory parlance) issuing a downgrade is not especially significant. Most investment mandates call for quality ratings by at least one or two NRSROs, and don’t require abiding by the lowest rating in the market or the rating of a specific vendor. Many guidelines consider government securities a separate category not subject to the minimum NRSRO ratings required of other debt securities. According to media reports, many investment managers huddled their compliance and legal staff over the weekend, analyzing client guidelines to assess what, if any, variances from mandates would need to be negotiated. Note that the inclination seems to be to renegotiate the terms of engagement, rather than sell from the downgraded category.
If anyone hoped for more constructive dialogue about what this objective view of U.S. finances and politics means, they’d be disappointed. The shrugs by many investors and defensive posturing by politicians probably reflect the poor repute of credit rating agencies generally, or the widespread recognition of the growing government fiscal crises, or both. Over the longer term, S&P’s attempt to tell it like it is may actually reduce the influence of rating agencies in the capital markets, as politicians mount defenses against these influential outsiders (by attempting to refute the rationale for the downgrade, and stripping references to ratings from many governing regulations), and investors busy themselves finding workarounds in their investment guidelines. Instead of the shove we needed to get our fiscal house in order, S&P’s action might be one more reminder that ratings don’t count for much anymore with many investors.