How good are credit ratings these days? Somewhat better than they used to be. That’s because mainstream agencies like Moody’s Investor Service, Standard & Poor’s, and Fitch Ratings, are trying to live down their pasts, in which they underestimated the perils of too much housing and mortgage derivative debt and abetted the financial crisis of 2007-08.
Today, these Big Three agencies’ conflicts of interest are laid bare. They are still paid by bond issuers, but everyone should know that now and realize the firms’ ratings are potentially suspect.
But one homegrown rating agency, Egan-Jones Ratings Co. in Haverford, has beaten this pack with aggressive downgrades of the United States, France, and now Germany.
Egan-Jones has a different business model: its analysts are paid for their research by investors rather than by bond issuers.
Last week, credit rating agencies tussled again at a conference sponsored by the Global Interdependence Center and the Philadelphia Federal Reserve. Egan-Jones senior analyst William Hassiepen noted his firm was the first in July to cut the U.S. government’s sovereign debt rating from AAA to AA+ with an “evolving” outlook.
(Standard & Poor’s downgraded the United States from triple-A in August. Moody’s Investors Service and Fitch both still rate U.S. sovereign debt AAA, a perfect credit).
If Federal Reserve Chairman Ben S. Bernanke were to flood the markets with a third round of liquidity – another bond-buying program known as QE3 for quantitative easing – “that would definitely trigger a review” of the U.S. rating, Hassiepen said. “And the review, I think, would not be favorable,” he told the audience of investors and Fed-watchers at the conference.
Investors should also be wary of European and U.S. banks. “There are issues in banking, particularly American banks, that should scare the daylights out of investors,” Hassiepen said. The problem is the banks’ vast size. The top six U.S. banks hold assets equal to 65 percent of American GDP; the top 3 banks in France hold assets of 240 percent of GDP and Deutsche Bank alone holds assets of 68 percent of German GDP, he said. So a failure could cause repercussions.
What about Germany, which will have to bail out Greece? In January, Egan-Jones cut its rating of Germany to AA- from AA, noting that the country will be stuck paying much of the bill for the European debt crisis.
“And can we have Germany rated higher than the U.S? No,” Hassiepen said. If the United States is downgraded again, Germany almost certainly will be downgraded too, he said. Investors should take heed that prices of those bonds will likely fall again and yields would rise as these nations would be forced to pay higher interest rates for borrowing.
In November, Egan-Jones was also among the first to downgrade the France’s sovereign credit rating, to A from AA-, citing the risk the country’s government would have to bail out its banks.
“It’s increasingly obvious that France is going to have to support its banks,” founder Sean Egan told Bloomberg News at the time. And sovereign ratings often affect countries’ banks.
Egan-Jones on Monday lowered the boom again, downgrading Portugal. That was significant because a lot of mutual funds are not allowed to buy “junk” bonds, and can buy only investment grade. So these ratings matter.
Separately, the Fed’s accommodative monetary policy has hurt consumers, Hassiepen said, noting that spiking gas and food prices were a drag on the U.S. economy. Meanwhile, American wages have not risen.
Additional bond purchases by the Fed falsely understate inflation because they weaken the dollar, Hassiepen said. Most major commodities are priced in dollars, so investors pour money into commodities as the dollar becomes cheaper. And yet, when the Fed looks at inflation, it removes prices of oil, food, and other commodities from the inflation index.
So Hassiepen would avoid Euro bonds unless investors can stomach the high risk. The European Central Bank is copying the Fed’s playbook of buying up government bonds and manipulating prices and interest rates.
Hassiepen said there would be buying opportunities in companies and industries that feed off inflation, such as oil and gas.