Why Hasn’t Moody’s Already Cut The US Debt Rating?

Moody’s has warned the U.S. that its paper may be downgraded if it defaults on its sovereign obligations after an August 2 deadline — the day by which the debt cap must be raised. The question is, since there is a real likelihood Congress and the Administration will not come to an agreement, why the agency didn’t already cut the rating to Aa from Aaa?

It has long been a mystery as to why the credit rating firms make their decisions when they do. Often they keep ratings too high for too long. This was certainly the case with mortgage backed securities pools, and credit agencies have been blamed as a cause for the credit crisis. There is still talk in Washington about oversight of the rating process because of those mistakes. There have been other cases where the firms’ rating changes came too late. The sovereign paper of both Ireland and Greece were downgraded in the last week. But large global money managers have already “downgraded” the debt and refused to buy Greece’s bonds unless the yields were astronomically high. The cost to insure Greek debt also soared. Credit rating agencies were weeks late in their actions if real market activity is taken into account.

Ratings can either be anticipatory or lagging. There are no other options. Investors can either be shocked by changes or find that they are nearly useless.

Moody’s has already weighed the chances that there will be no debt ceiling agreement by August 2. The risk rises as each day without an agreement passes. Moody’s will almost certainly not act on a downgrade until the deadline, which means its opinion will be useless to global capital markets. Investors will already have weighed their options in late July and August 1. The effect on Treasuries will be seen if a compromise between the White House and the Administration becomes close to impossible.

Moody’s, S&P and Fitch lost their ways in the credit crisis three years ago. They have not found equilibrium since then. The public and politicians may pay attention to the headlines in their ratings press releases, but not the details. That makes them useless. If the risk of a U.S. default is high, the rating of American paper should have already been dropped. Perhaps the agencies are concerned they will cause a panic that will roil global capital markets. Probably not. The smart money did not get smart by following credit agency decisions. And Moody’s can always move an Aa rating back up on August 3 if a decision on the debt cap turns out for the best.

Douglas A. McIntyre