This is indeed impressive, the Sage of Ely manages to encounter yet another area of life upon which he has strong opinions and no understanding. This time it’s the ratings agencies:
The idea that UK debt is AA- is absurd. Sovereign debt is the one asset that cannot fail to pay right now: the government can and always will pay, come what may, by issuing the cash to do so. And the queue for government debt is considerable: £45 billion will be sold this month without problem.
The rating agencies are, then, living on another planet far removed from reality, and are subscribing to an economic logic that is disconnected from the facts. If they do not appreciate that very soon my simple answer would be that the government rule that its debt is always investment grade and dispense with their services – after all, they pay for this nonsense; the agencies don’t do it for free.
Of all the problems we face the risk that government debt is no longer investment grade is about the smallest: just as money can be created by a few keystrokes, so too can this be addressed with a few words in a statutory instrument, which is precisely what I’d be preparing if in the Treasury now.
There is that delicious little point that the agencies don’t do it for free. When, of course, reality outside that window has the ratings agencies doing exactly that.
For corporate and other private sector issuances of debt the standard model is issuer pays. The issuer signs up one of more of the ratings agencies to give their opinion. Investors then take note of this.
The background problem here is the asymmetry of knowledge. The issuer knows more about their own accounts and prospects than any potential investor does. As Mr. Janet Yellen got the Nobel for this means markets are at best inefficient, at worst don’t exist. The solution to which is intermediaries producing that information that investors lack. Here it’s bond ratings, in used cars it’s the Blue Book, Glass’s, the AA charging £50 to check a dodgy motor for you.
Ratings agencies are a solution to a problem.
With sovereign issues matters are different. By and large – actually, by large, small places might well have to – sovereigns do not pay ratings agencies. I sorta knew this but thought I’d better go and check. The Bank of England said ask a ratings agency. Fitch – the subject under discussion here – agreed with me that “unsolicited” is the phrase used to show that the issuer has not paid the ratings agency. The agency is providing information to investors without being paid by the government issuing the bond that is. This information is at the bottom of each ratings page. As Fitch emailed to me:
And at the bottom:
And so on and etcetera. The UK government is not paying Fitch for these sovereign ratings.
But mere ignorance of fact is not enough for the Retired Accountant from Wandsworth. we also have ignorance if implication, of outturn or effect.
So, what would be the effect of a government ruling that all of its debt was investment grade and forever? We don’t in fact have to guess about this, we can just look back into recent history. For governments did do just that and the result was that the banking system fell over.
Governments set the prudential limits. How much a bank can lend to whom. Things like no more than x% of the capital base to one borrower say. Or how much capital must be set aside a holding in an asset of what class. And back when they said that sovereigns, those government bonds, were so safe, so super duper investment grade, that no capital needed to be held against a holding of sovereign bonds.
So, European banks, those within the eurozone, loaded up on government debt. More specifically, German and French banks looked at the yields on their domestic debt and weren’t impressed. Now it’s all the eurozone there’s no exchange risk on owning other sovereigns also in the eurozone. Some of which had higher yields.
And, guess what? By declaration those foreign sovereigns were investment grade, so much so that no capital had to be held against positions in them. Which is how the French and German banks all went bust when Greece defaulted.
Or, at least, would have done if everyone hadn’t bailed out Greece for long enough that those banks could dump their holdings. Which is what Greece is paying off right now, the state holdings of what the French and German banks dumped to socialise their losses.
All of this being less than a decade in the past. And yet Spud You Don’t Like is entirely ignorant of the effect of governments simply declaring their own debt to be entirely investment grade Oh Yes Siree It Is!
This before we even use the example of Greece as a place where sovereign debt is always paid, long before we get to Zimbabwe and Venezuela, Argentina and so on.
Heck, we might even look at Reinhart and Rogoff and note that sovereigns have defaulted some 800 times over the past few centuries. To the point that Greece has spent more of its independent history in default than it has out of it.
Or perhaps not. For acknowledging reality would be such a deflater of Richard Murphy’s theories and really, who wants to be that mean? He’s having such fun putting the world to rights after all….