S&P has gone on a downgrading spree recently, with the sovereign debt of several European economies like France downgraded from the top rating. Fitch and Moody's have not deemed it necessary to revise the credit ratings of the sovereign debts of France and several other countries whose ratings were downgraded by S&P. The same was true when S&P last downgraded US treasury bonds. Moody's and Fitch kept the US treasury bond ratings unchanged.
The US credit rating change led to a flurry of activity in Washington in the area of budget deficits. However, the final outcomes of all these confabulations involving the White House, the Congress and the debt reduction committees has been disappointing. There is
a troubling lack of willingness to consider tax increases or to let elitist tax cuts expire. The spending cuts that have been announced or envisaged will most probably be insufficient to impart stability to the long-term trajectory of US public debt.
As for the US treasury bond market, the rating downgrade has not seriously impaired the ability of the US government to finance its
deficit. It is probably due to vestiges of conventional modes of thinking along the lines of " the US is too big to fail ". However, the Great Recession and the terrible travails that have beset the US private sector and the government sector in the last few years should alert us to the fact that this kind of superficial thinking will only invite future woes. That the Washington establishment
is making some efforts to improve the short-term and long-term fiscal deficit situation is probably serving to prevent any excess of
negative sentiments in the US treasury bond market. However, the fact that these measures are insufficient means that rational
nvestors will have to react at some stage to the possibility of future deterioration in US public finances.
As for the recent European downgrades, the market has decided to ignore them, at least for the time being. Some European countries have gone for a more sensible approach to the public debt crisis compared to the United States. They have combined specific tax hikes with some spending cuts. Among other things, this ensures that the burden of austerity is shared by the rich as well as the poor, by those in need of economic assistance and by those that are thriving in the midst of economic tribulations. While the US establishment has adopted a hidebound approach whereby tax increases are almost anathema, the more mature direction that these European countries have taken should inspire higher confidence in the minds of rational investors when it comes to pricing the government bonds. The markets may have decided to ignore the credit ratings downgrades by S&P in Europe and in the United States for different reasons. The European approach uses a more balanced methodology by not relying too much on spending cuts alone. It has higher chances of leading to a successful resolution of budget impasses and of ensuring the successful continuation of meaningful social welfare systems and economic prosperity.
The fact that the markets are ignoring the credit rating downgrades by S&P may mean that in the future, credit rating agencies may have to recommend asset prices and not just assign grades. Even with the grading system of the credit rating agencies, individual and institutional investors can do their own analysis and arrive at what they think are the best and most rational asset prices. Quantification acquires greater significance when investors look for direction in the midst of unprecedented economic turbulence.
Credit rating agencies may well have to start reporting recommended asset price ranges and hard analysis supporting these
recommendations to the public.
by C. Jayant Praharaj ( send comments to [email protected] )