Ratings Agency Downgrade: An American Tale

How often do private corporations make deliberate decisions that are clearly contrary to the interests of their own home nations? Less often than you’d think, considering the claims of the corporations.

Although many firms close down local factories and move jobs overseas, for instance, they generally claim to do so to support the interests of their domestic shareholders. After all, citizens of western nations invest their retirement assets in the stock and debt securities of those firms, and thus reap the benefits of their reductions in operating costs.

There are also numerous instances of investigative news organizations who report on government malfeasance and ineptitude in newspapers and on television stations. They too, though, claim to be acting in their nations’ best interests by protecting the rights and well-being of the local citizenry.

But corporations seldom decide to take actions that blatantly damage the interests of their own home governments. Last week, however, the rating agency Standard & Poor’s (S&P) did exactly that … and, in doing so, highlighted unique features of the American market system.

The Ratings Game

The American system of economic governance has emerged to dominate our current global system. The day has passed when global leaders like Mikhail Gorbachev of the Soviet Union could talk of promoting alternatives to the capitalist model; even Cuba, for instance, has recently conceded that its citizens should possess the right to buy and sell private homes.

Under the American system, ratings agencies are trusted to independently review organizational track records and opine on their fiscal health. But the agencies are hired by the organizations themselves, often after outbidding other agencies for the business contracts. Organizations hire ratings agencies to examine their books, interview their personnel, and issue reports that recommend (or warn against) investments in their own equity and debt offerings.

Some critics complain that ratings agencies can’t be trusted to independently assess the fiscal health of organizations if the firms actually audition and hire the agencies. Nevertheless, the American system has always featured private contracts and free market competition, resulting in the current system of agency review. And today, three ratings agencies rule the roost: two larger firms based primarily in the United States, and a smaller one with a major presence in America as well.

Profiling The Three Agencies

S&P and Moody’s, the two larger firms, are icons of American capitalism. S&P, established in 1860 by publisher Henry Varnum Poor with an investment guide book about railroads and canals, is now owned by McGraw-Hill and is headquartered on the outskirts of Rockefeller Center in New York City. And Moody’s, established in 1909 by publisher John Moody with another investment guide book about American railroads, is headquartered in New York City as well, in the financial district of downtown Manhattan.

Fitch was founded by yet another American financial publisher, John Knowles Fitch, in 1913 in New York City; it is now a British-American subsidiary of a French firm. It is far smaller than its two established rivals, though, and is sometimes positioned as a “tie breaker” agency that is only consulted when S&P and Moody’s disagree on an assessment of an organization.

During the past few weeks, all three ratings agencies — which assess the financial health of the federal government of the United States on behalf of investors who purchase treasury bills and other government debt securities — warned that they might “downgrade America” in reaction to Washington’s recent debt ceiling debate. In fact, a relatively small Chinese rating agency named Dagong actually took that unprecedented step, but few pundits initially believed that the American ratings firms would do so as well.

But then, last week … S&P did exactly that.

An Awkward Process

As can be expected during such a contentious debate, the process by which S&P announced and then explained its downgrade was an awkward one. S&P began its work by presenting its findings to the American Department of the Treasury, which angrily disagreed with the agency’s assumptions and even discovered — and then publicly complained about — the agency’s mammoth $2 trillion calculation error.

Then came a vociferous public debate about S&P’s professional level of technical competence, with some pundits questioning the agency’s ability to assess political trends while performing its financial analyses. Some critics recalled the recent unwillingness of the agencies to raise alarms about potential market failures; others reminded the public of a particular rating agency’s infamous self-declaration (via a waggish private email conversation that was publicized during a Congressional investigation) that its own analysts would rate anything … even a deal “structured by cows.”

The debate continues today, and will undoubtedly rage on until Moody’s and Fitch choose to either join S&P in its downgrade decision, or to reaffirm their faith in America’s fiscal strength. The fact that they are even considering a downgrade, though, is an illustrative indicator of the unique characteristics of the American private market system.