Some Thoughts On The Ratings Agencies

While the Moody’s downgrade of Ireland isn’t any surprise, coming on the heels of S&P’s move last week from A+ to BBB+, the sheer magnitude of five notches warrants a mention.  We haven’t seen anything like this since the Asian crisis, when S&P took Korea down by four notches on December 22 1997 from BBB- to B+.  And that was after a three notch downgrade just eleven days earlier from A- to BBB-, a two notch downgrade on November 25 from A+ to A-, and a one notch downgrade a month before that on October 24 from AA- to A+.  That’s total of ten notches over the course of two months.  It wasn’t just S&P, as Fitch took Korea from AA- down to B- (twelve notches) over the course of one month in 1997, including a six notch move on December 23 1997.  To us, that crisis was when the credibility of the ratings agencies went out the window, as investors were simply astounded as to how far off the agencies had really been.  What’s worse, both S&P and Fitch turned right around and put Korea back to investment grade BBB- in January 1999, a little over a year later.  Really?  Country creditworthiness changes largely over time, not overnight, and so it is simply inconceivable that a country like Korea could be marked down and then up by so much so quickly.

Fast forward thirteen years and here we are again.  Rating agencies missed the boat on the peripheral euro zone, and are now trying to play catch up and perhaps even overcompensate to the downside.  We actually agree with Moody’s keeping the negative outlook on Ireland, as our sovereign ratings model now puts it as a BBB/Baa2/BBB credit vs. actual ratings of A/Baa1/BBB+.  Clearly, S&P is way out of line and so we look for a catch up downgrade soon.  As we wrote in our FX daily, the EU summit provided no framework to deal with the crisis now, instead choosing to remain focused on 2013.  Peripheral euro zone doesn’t have the luxury of time right now, and so European policy-makers have once again fallen short.  With heavy debt issuance schedule for the periphery in Q1 11 going hand in hand with rising borrowing costs, the debt dynamics continue to break down.  We foresee ongoing downgrades for peripheral (and perhaps even some core) euro zone countries over the course of 2011 (see table below), as the debt ratios are going to get much worse before they get better.