Super-Downgrade Me!

Thursday August 18th, 2011   •   Posted by Emily Skarbek at 10:52am PDT   •  

Since last summer, the top 3 ratings agencies (S&P, Moody’s, and Fitch Ratings) have made 196 “super-downgrades” on municipal bonds, according to research popularized in today’s Wall Street Journal. Super-downgrades are defined as cuts of at least three grade-letter scores on the traditional scale used by the firms.

For example, when the US treasury was downgraded by one letter, its ratings dropped from AAA to a AA+. Standard & Poor’s “super-downgraded” Manassas Park, Virginia from AA- to BBB – a five-notch tumble.

The political economy of downgrading debt is palpable. Consider the following paragraph of the WSJ piece:

Critics say super-downgrades are unfair punishment by the major firms responding to heightened focus by regulators on the timeliness and accuracy of their ratings. Their actions are “not about rapid credit erosion this year or last year,” says Matt Fabian, managing director for Municipal Market Advisors. “It’s about several years of things getting worse, and the rating agencies weren’t able to catch it.”

What’s striking about this chain of reasoning? The supper-downgrades are supposed to reflect expectations about the political institutional environment of debt and repayment. The fact that downgrades are coming after years of over-spending could in fact reflect caution and uncertainty on the part of ratings agencies while attempting to do their best to price institutional risk.

I am not one to assume that ratings agencies are perfect or that their ratings are 100% accurate and up-to-the-minute. The lessons of credit default swaps and mortgage back securities should have taught us something. Nevertheless, in my opinion, public skepticism should shine most brightly on the politicians and public policy makers that have paved this path to the debt crises – federal, state, and local – we find ourselves in. Let’s place the blame where it’s due and recognize when political payback is masquerading as public interest.

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August 2011