Credit Ratings: What Do The Credit Rating Agencies Rate?

It may just be me, but aren’t the credit rating agencies supposed to be rating credit?

Yesterday (Thursday), we saw a sharp market reaction when one of the rating agencies that gave AAA ratings to mortgage-backed securities larded with subprime loans called into question the credit worthiness of Britain. As is the case with the United States and the Federal Reserve, Britain and its Bank of England have the ability to create new money if necessary to pay off its debt at maturity. There is no sovereign credit risk. There is no need for credit rating agencies to opine on the credit worthiness of sovereign debt.

Sovereign debt is subject to interest rate risk. When interest rates in general rise, outstanding bonds, sovereign and non-sovereign, will decline in price, the extent depending on how close they are to maturity.

Sovereign debt is also subject to inflation risk. Holders of the debt are harmed if inflation outpaces their expectations when they purchased the debt.

When Standard & Poor questions British bonds, they must be making a judgment about some risk other than credit risk. Given time, investors will learn to take such questions with a grain of salt and not overreact. Meanwhile, haven’t they done enough harm for this cycle?

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Comment by carlco

2009-05-22 13:50:59

absolutely, knee jerk reaction followed by immediate correction , what this episode has done is to focus attention back on US debt levels just how is the debt going to be repaid ?

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