[August 10, 2011] OPINION: U.S. debt & the ratings game Tweet Aug 06, 2011 (The Pittsburgh Tribune-Review - McClatchy-Tribune Information Services via COMTEX) -- Lawrence J. White was senior staff economist on the president's Council of Economic Advisers in 1978, served on the board of the Federal Home Loan Bank from 1986-89 and has been a consultant to numerous government agencies. A professor of economics at New York University's Stern School of Business, he has testified before House and Senate committees on U.S. credit rating agencies and has written extensively on the issue. We spoke by phone Tuesday after the president and congressional leaders announced a deal to raise the debt ceiling. Q: Do the credit-rating agencies have too much power? A: You said this was going to take 10 minutes; how about 10 hours? I'm only half-joking, OK? Only half-joking. ... The answer is yes, they do because the financial regulators over the past 75 years, with perfectly good intentions, have established a bunch of regulations that did give them too much power, too much prominence, too much influence in the bond markets. That's correct. Q: It's a pretty cozy arrangement with the government, the "protective wall," as you call it. A: That's right. Unfortunately that's right. Again, all of this, you can see the good intentions, but we know which road leads in which direction being paved with good intentions. Q: They've had some pretty high-profile missteps -- Enron, WorldCom, Lehman Brothers. You've testified they played a central role in the subprime market debacle. Do they provide useful information? A: Unfortunately nobody knows the answer to that. You ask them and, of course, they will tell you yes. You ask an academic who has thought about this issue, and he or she will say the jury is out, we don't know the answer. I think if you asked somebody like Bill Gross at PIMCO, the Pacific Investment Management Co., he would say no. And certainly if you asked Sean Egan at Egan-Jones, he would say no. ... Because they are so entangled in the prudential regulatory structure of banks, insurance companies, pension funds, money market mutual funds and broker/dealers, you can't tell whether a change in a rating which causes markets to move -- there is no doubt that is a true phenomenon when they change the ratings. They change them down, markets react unfavorably. They change it up, markets react favorably. But is this telling the market something new that the market didn't previously know about default likelihoods, default probabilities? Or is it simply telling the market a change in the regulatory status of this bond, which would influence what the market wants to do -- either sell or buy -- but really hasn't provided any new default probability information, which is what the credit rating agencies were put on God's green earth to be doing. Q: The president and congressional leaders reached a deal to raise the debt ceiling and we're still hearing reports (on Tuesday) that the big three (Moody's, Standard & Poor's and Fitch) haven't made up their minds whether to lower the U.S. credit rating. What does that tell you? A: Look, first remember that, yes, they have screwed up really bad. That's a technical term. They screwed up. They screwed up big time, really badly in the mortgage, residential mortgage securities area. Just horribly. They were one of the central players, central reasons for the financial debacle ... . However, in the area of plain-vanilla corporate debt, municipal bond debt, sovereign government debt, they haven't really screwed up. Their reputation is largely intact. They have been slow, they were slow in Enron, in WorldCom. They were slow with Lehman. But that slowness is a cultural thing that goes back at least 80 years and is not, as best I can tell, related to the conflict-of-interest problem that did lie at the heart of their screw-up in the mortgage-related area. So their reputation in terms of dealing with things like government debt is still pretty good . ... What does a AAA (rating) mean? It means extremely unlikely to default. Given what we've gone through over this past couple of weeks, can one really use the adjective "extremely" anymore? Now if you go from AAA to AA that doesn't mean that the bonds are going to default tomorrow. It isn't that kind of yes/no. All it means is it's still pretty unlikely that the bonds would default, but we just can't use the word "extremely" anymore. I'm a little surprised that over this past weekend we didn't see downgrades. ... The government of Japan is AA; for a long time the government of Australia was AA. These guys haven't defaulted. They're not likely to default, but just a couple of years ago Moody's and Standard & Poor's said, "We just can't use the word 'extremely' anymore." And so we downgrade from AAA to AA. I thought the same thing would happen over this past weekend. It hasn't, and so at this point you could still see why they would be chewing on the question, "Should we, given what we've gone through, should we say the U.S. is no longer AAA because we can't rule out the possibility a year and a half, two years from now we'll go through the same exercise again and, gosh, maybe that time something will go wrong?" Somebody will decide to go out for lunch rather than attend a vote ... . I mean can you use the words "extremely unlikely" anymore? To see more of The Pittsburgh Tribune-Review or to subscribe to the newspaper, go to http://www.pittsburghlive.com/x/pittsburghtrib/. Copyright (c) 2011, The Pittsburgh Tribune-Review Distributed by McClatchy-Tribune Information Services. For more information about the content services offered by McClatchy-Tribune Information Services (MCT), visit www.mctinfoservices.com. [ Back To TMCnet.com's Homepage ]