By James Kwak
Everyone (well, the media at least) seems to be acting as if Moody’s downgrading the United States would be a bad thing. I feel like I must be missing something.
First of all, we know what bond ratings are worth. See, oh, the entire past decade for evidence. (It wasn’t just mortgage-backed securities; they didn’t downgrade Enron until after the SEC announced an inquiry and CFO Andrew Fastow was forced out, and less than five weeks before the company declared bankruptcy.)
Still, the point of bond rating agencies is to do research on securities that other investors may not know well. If I’m a buy-side investor, I don’t have the time to review tens of thousands of different debt securities I could buy. It makes sense for me to turn to someone like Moody’s or S&P, because I can count on them to do at least some level of research and analysis on them. In other words, the ratings may not be great, but they still carry information.
But this is emphatically not true when it comes to U.S. government debt. Enormous amounts of information about the government’s finances are open to the public and are pored over by thousands of analysts from all around the world. Moody’s is no better at estimating future tax revenues and spending commitments than anyone else.
On top of that, we all know that the short-term likelihood of default has nothing to do with the government’s finances. It’s all politics, and it’s all in the spotlight. We have thousands of politicians, reporters, commentators, and academics expressing their opinions on the likelihood of default. Every major institutional investor has its own opinion about whether the government will default next month. Moody’s has no competitive advantage in this game, so it’s just one more opinion, and not a particularly trustworthy one.
Since it seems preposterous to me that anyone could care about the informational content of a Moody’s downgrade, I’m guessing that people are worried about the legal-mechanical consequences of a downgrade — in particular, the requirements that some investors (money market funds, some other mutual funds, maybe pension funds and insurance companies) must invest some proportion of their assets in AAA securities. If, say, every money market fund suddenly has to dump all of its T-bills, that could cause systemic problems.
But in that case, what is Moody’s thinking? Would they really express their opinion by downgrading Treasuries, knowing (a) that no one cares about their opinion itself yet (b) it could trigger a financial crisis? That sounds to me like just about the most irresponsible thing one can imagine — blowing up the global financial system to express an opinion that no one would care about except for the fact that large amounts of money are mechanically tied to it.
So I must be missing something. What is it?