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Credit Rating Agencies – how countries stack up.
Here is a list of the latest ratings by the three main rating agencies. Notice that Australia and the three Scandinavian countries have top ratings. The UK lost its top rating from Moody’s but maintained the top rating from the other two. New Zealand comes in further down with a top rating from Moody’s but has lost its top grade from the other two. When you get to B status your are talking high risk or junk status and this is quite evident with the PIGS counties.
If you have watched the movie documnetary ‘Inside Job’ you will remember that these 3 credit rating agencies also rated high risk investments – sub-prime mortgages – as AAA, up to a week before they failed. The same could be said about their rating of investment company Bear Stearns.
Ultimately they could have ‘stopped the party’ but delayed ratings reports and made junk status investments AAA rated. But as they testified in front of congress their advice to clients are opinions ‘just opinions’ – I wonder do they share the opinions of those that lost huge amounts of money, including sovereign investments. Recently they downgraded Greece and Spain in the knowledge that the servicing of the debt would now become more costly for those countries and stifle any sort of recovery in the near future.
Is it surprising that Greece got into such a mess?
The Greek economy, burden with huge government debt, continued to adopt stringent austerity plans in order to secure a bailout from the European Union. Although markets received the news of an emergency package for Greece with a positive view one wonders if anyone actually understood the package in the first place. Greece is getting a further €109bn in soft loans from the eurozone and the IMF over the next 3 years taking its overall package to around €200bn. Credit rating agency Moody’s downgraded Greek debt to junk status on the grounds that default is virtually certain. This also affects other economies in the Eurozone (Italy and Spain) as they now know that bailouts from northern countries won’t be forthcoming if they have to take “haircut” (loss).
Will it work? I am not sure as Greece’s debt-to-GDP ratio will still be around 130% and there are few “engines of growth” available to get the economy back on the rails. But is this situation that Greece finds itself in a surprise to any of us?
Tax evasion a Greek national pastime
For years Greek governments have struggled to collect enough taxes to fund their spending. The gap between what tax payers owed last year and what they actually paid was approximately 33% of total tax revenue – about the size of the country’s budget deficit. The “shadow economy” in Greece accounts for approximately 27.5% of GDP and this culture of evasion has the effect of burdening those that are honest and pay their taxes. Greek officials are well known as easy to bribe with cash and there has been little enforcement especially around election time. According to James Surowiecki in “The New Yorker” Greece, with Bulgaria and Romania, is seen as the most corrupt country in Europe.
It is a vicious cycle – as tax evasion is prevalent everywhere people trust the system less, which makes them less inclined to pay taxes. Therefore the government makes up the shortfall by raising taxes on those who do. This then increase the motive to not pay taxes at all. A social inclination toward tax evasion is hard to eradicate and Greece needs more than a policy shift but a cultural one. One wonders how they were able to afford to host the Olympic Games in 2004?
US downgrade not surprising as integrity of agencies at stake
The recent downgrade of the US economy by credit rating agency Standard & Poors shouldn’t have come as a surprise. S&P indicated that even if the debt deal was approved they would still go ahead with the downgrade if there wasn’t a reputable policy of fiscal contraction to reduce debt. But agencies are all to aware of the critcism that they got over the credit crisis and will be mindful of this.
Conflict of Interest
Rating agencies are paid by the people whose products they grade and they are competing against other rating agencies for the business. Subsequently the rating agencies were being played-off against each other by the bankers in this market and this led to a systemic decline in standards and willingness not to check the underlying information as thoroughly as possible for fear of losing the deal. Even the rating agencies themselves admit mistakes were made is assessing sub-prime debt and that there were issues to do with data quality from their sources of research. However one has to consider whether the world have been better off if credit rating agencies had not existed as pension funds, bond funds, insurance companies etc would have had to do a lot more of their own research on what they were buying.
Remember before the credit crisis AAA investments mushroomed between 2000-2006 see graph below.
But consider the following:
Bear Stearns – rated A2 a month before it went bankrupt
Lehman Brothers – rated A2 just days before it collapsed
AIG – rated AA within days of being bailed out
Fannie Mae & Freddie Mac – AAA rating before being bailed out by the government
Citigroup – A2 before receiving a bail out package from the Government
Merrill Lynch – A2 before being sold to Bank of America
A2 is considered a good investment grade
Below are the ratings that each company uses.
Why have New Zealand’s interest rates been higher than other OECD countries?
The April Economic Overview publication from Westpac Bank published a feature article focusing on why New Zealand has relatively high interest rates. A paper written by Treasury came up with two views:
1. The Risk Premium View
2. The Excess Demand View
The Risk Premium View
Interest rates in different countries can diverge with different perceptions of risk or inflation. Although New Zealand’s inflation or exchange rate are not volatile in relation to other countries, there is unusually high levels of nationla debt. While our government debt is relatively low in comparison to other countries it is our overall debt which is running at 80% of GDP which is causing concern. This would tend to push up interest rates higher than other countries with lower debt levels, while also pushing the exchange rate lower than it would otherwise be. The graph below plots the average inflation-adjusted interest rates against net foreign debt for a range of countries, suggests that this is broadly true.
The Excess Demand View.
The exchange rate can increase especially as investors look for higher yields as a country might have higher intesest rates – known as the ‘carry trade’. Investors will pile into higher-yielding currencies only up to the point where the exchange rate has become sufficiently ‘overvalued’ for its expected depreciation to offset the prospective interest rate gains. Elaborating on the carry trade idea the significant amount of aggregate demand in the NZ economy has kept the NZ$ high. This strong level of domestic demand has been to the detriment of savings and has also meant that the Reserve Bank has had to keep interest rates above those countries that have higher savings rates. Furthermore increases in domestic demand have meant:
- a higher trade deficit
- significant foreign debt
- an overvalued exchange rate
Is saving the answer?
Saving is not by itself the panacea however there is a high liklihood that there could be lower interest rates and a lower exchange rate. Higher savings would also be rewarded with lower borrowing costs but contrary to the first point, lower foreign debt servicing costs and a more positive report from the credit rating agencies the NZ$ would be inclined to appreciate.
New Zealand’s Credit Rating – downgrade?
I did an earlier posting on Credit Rating Agencies explaining who they are and how they work. The table right (from the Parliamentary Monthly Economic Review) shows the three credit rating agencies and the current rating that New Zealand has as an economy.
It wasn’t until 1977 the New Zealand was actually rated by S&P and Moddy’s – Fitch came into the picture in 2002. You can see from the table that S&P reviewed New Zealand in November 2010 and while maintaining its rating at AA+, they changed the outlook from stale to negative. Fitch also gave NZ the same rating. This means that there is a higher chance of a downgrading which would mean higher interest costs to the government.
Standard and Poor’s raised concerns around the level of New Zealand’s external imbalances, and the weakening of fiscal flexibility for their change in outlook. The
negative outlook on Fitch Ratings’ credit rating for New Zealand is also based on the economy’s imbalances, with the level of the country’s current account deficit and international debt being mentioned.
Following the Christchurch earthquake in February 2011, Moody’s Investor Services made an announcement that they saw no reason to reconsider their Aaa credit rating for New Zealand, although they noted that it would likely “result in another one-time rise in government debt”. The credit rating agency noted that New Zealand government debt levels were below the median for other Aaa-rated governments globally. The Agency stated that it would wait for a fuller assessment of the impact on government debt, when the 2011 Budget is presented.
What does this mean for New Zealand?
The 2011 budget will no doubt assure credit rating agencies that a downgrade is unnecessary and therefore Bill English will provide little fiscal stimulus. In a pre-budget presentation English hinted at $1 billion of new spending mainly in health and education, but this will be “substantially offset” by cuts in other, lower priority, areas.
Economics in 2010 – DRINKBONDS, ALKIBONDS and PUKEBONDS
Here is something I got which was doing the rounds on email – very amusing.
________________________________________________________________________________________________________
I was asked to explain the Economic crisis in Ireland here is an example
as I understand it….( passed on of course !!)
Mary is the proprietor of a bar in Dublin . She realises that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronise her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Mary’s “drink now, pay later” marketing strategy and, as a result, increasing numbers of customers flood into Mary’s bar. Soon she has the largest sales volume for any bar in Dublin. By providing her customers’ freedom from immediate payment demands, Mary gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Mary’s gross sales volume increases massively. A young and dynamic vice-president at the local bank recognises that these customer debts constitute valuable future assets and increases Mary’s borrowing limit. He sees no reason for any undue concern, since he has the debts of unemployed alcoholics as collateral.
At the bank’s corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on international security markets. Naive investors don’t really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation’s leading brokerage houses.
One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Mary’s bar. He so informs Mary. Mary then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since, Mary cannot fulfil her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.
Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset value destroys the banks liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Mary’s bar had granted her generous payment extensions and had invested their firms’ pension funds in the various BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion euro no-strings attached cash infusion from their cronies in Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in Mary’s bar.
Now, do you understand economics in 2010?
NZ$ falls with S&P rating and Korean clash
The NZ$ dropped to its lowest level for 4 weeks against the US$ – now at US$0.76 from a high of US$0.79. Two main reasons for this:
1. New Zealand has the second-highest possible rating, AA+, but Standard & Poors (credit rating agency) has revised its outlook from stable to negative – one-in-three chance that NZ will be downgraded. It is New Zealand’s external position that is the main issue – kiwis borrow more than other kiwis are willing to lend. Net international liabilities of the country (as distinct from the Government) at the end of June were $164 billion. S&P said it seemed likely that as the economy strengthened, the problem of big deficits and ever-rising overseas debt would return, “and possibly with a vengeance”. This information for foreign currency dealers means that there is more risk attached to holding NZ$’s therefore you tend to see a sell-off on the market – supply curve to the right = price drops.
2. The clash between North and South Korea has brought about instability in the area and also made investors risk averse to regional currencies including the Aus$. Most of them have returned to the relative safety of American and Japanese bonds or even the US$. With the turmoil in Ireland and the concern that the rescue package from the IMF and the EU won’t be enough investors are tucking for cover. Additionally other countries with high levels of debt, in particular Portugal and Spain, may also have to seek financial help.
NZ debt – the good news and the bad news
Despite a glowing report from the IMF which stated that New Zealand has the second smallest government debt among 23 developed countries, credit rating agency Standard and Poor’s (S&P) has indicated that the overall level of debt has the country vulnerable. Treasury estimate govenment debt to be 27% of GDP by 2015 but this compares to total net debt at 90% of GDP with much of this in the private sector. 
Their concern is that if there is a major budget crisis in other countries this could make markets nervous about investing in high debt economies – both government and private debt. New Zealand is borrowing up to $240 millilon dollars a week and if the former were to happen interest charges on that borowing would go up (maybe a downgrade by credit rating agencies) which ultimately would effect growth in the economy and the NZ$. S&P suggest that there is a need to rely less on foreign funds and generate more export revenue especially from the Asian markets. The balancing act is making sure that debt as a % of GDP doesn’t get too high but at the same time generating growth in the economy. Click here for Brian Fallow’s column in the NZ Hearld.
