The news of the last week or so has been full of Ratings Agencies downgrading banks, bonds, debts and even entire nations. So now seems like a good moment to look at what it is the Ratings Agencies, Moodys, S&P and Fitch, actually rate? What do they consider in coming to their conclusions and can they be said to in any way be objective?
What people like me used to think, if we ever considered the subject at all, was that the Ratings agencies looked at the details of financial products, such as bonds and securities, and much like “What Car?” does for cars they would give an informed, expert review based on lots of technical comparisons and standards. It was nerdy stuff for finance wonks.
If that was ever really the case, it certainly isn’t now. And the key to understanding why not is the term “Support Uplift”. Support Uplift is the term used to describe how much financial “support” a national government is giving or is likely to give to its banks. By ‘financial support’ the agencies mean any and all of the various bail-out and bail-in measures from buying of bonds to taking bad debts on to the public purse – anything which ‘helps’ the bank.
On one level this seems both straightforward and reasonable. The agencies are trying to ascertain the likely health of a bank, or some bonds or a Nation and since part of that calculation is figuring in any help the banks, bond issuers or nations can expect to receive, it’s only reasonable that the agencies take it in to account.
The problem is that ‘support uplift’ is actually quite unlike the rest of the data the agencies use. When Moodys ‘measures’ and figures in the amount of ‘support uplift’ a bank is expected to get from a government what is being measured? Here’s a quote from a
Daiwa Securities research note looking at ratings and downgrades.
According to Moody’s, the senior debt ratings of European banks incorporate an average of 2.5 notches of systemic support uplift.
It sounds reassuringly professional, financial and technical, but is it? The ratings in question do incorporate lots of technical financial numbers: Interest rates being paid, durations of liabilities, risk quotients on those loans, capital holding risk weighted by type etc. But “systemic uplift” is a ‘measure’ of what a government might do and how likely it is to do it. What the government ‘might do’ might be considered financial but how likely it is to do it and for how long it will have the political mandate to do it is political and ideological. And yet it is being slipped in with the rest of the data.
This might not be important when ‘support uplift’ is a very minor consideration – when all is well. But we all know that for the last three years and for the foreseeable future ‘support uplift’ is the difference between solvency and death for the banks.
From the same report,
The below chart highlights the number of notches of support factored into Moody’s senior unsecured ratings for some of Europe’s largest banks.
The reliance of UK bank ratings on support uplift is notable. It was, therefore, unsurprising to see Moody’s place the senior ratings of the majority of UK banks on review for possible downgrade just this morning as it seeks to reassess the level of support it incorporates into these ratings.
Moody’s senior unsecured ratings and “notches” of systemic support uplift
Source: Moody’s and Daiwa Capital Markets Europe Ltd.
A notch is one whole rating level from say, Aaa to Aa1 in Moody’s terminology. So for RBS for example to have ‘support uplift of 5 notches means actually the fate of the bank is determined by this one non-technical political part of the assessment. Remove government support for RBS and it drops 5 notches which would kill it. Here a chart of the ratings so you can see for yourself what 5 notches is.
| Moody’s |
S&P |
Fitch |
|
| Long-term |
Short-term |
Long-term |
Short-term |
Long-term |
Short-term |
|
| Aaa |
P-1 |
AAA |
A-1+ |
AAA |
F1+ |
Prime |
| Aa1 |
AA+ |
AA+ |
High grade |
| Aa2 |
AA |
AA |
| Aa3 |
AA- |
AA- |
| A1 |
A+ |
A-1 |
A+ |
F1 |
Upper medium grade |
| A2 |
A |
A |
| A3 |
P-2 |
A- |
A-2 |
A- |
F2 |
| Baa1 |
BBB+ |
BBB+ |
Lower medium grade |
| Baa2 |
P-3 |
BBB |
A-3 |
BBB |
F3 |
| Baa3 |
BBB- |
BBB- |
| Ba1 |
Not prime |
BB+ |
B |
BB+ |
B |
Non-investment grade
speculative |
| Ba2 |
BB |
BB |
| Ba3 |
BB- |
BB- |
| B1 |
B+ |
B+ |
Highly speculative |
| B2 |
B |
B |
| B3 |
B- |
B- |
| Caa1 |
CCC+ |
C |
CCC |
C |
Substantial risks |
| Caa2 |
CCC |
Extremely speculative |
| Caa3 |
CCC- |
In default with little
prospect for recovery |
| Ca |
CC |
| C |
| C |
D |
/ |
DDD |
/ |
In default |
| / |
DD |
| / |
D
|
Thus while the ratings agencies do all the financial number crunching and present their findings as the product of technical know-how and expertise, giving them a patina of objective quasi-scientific respectability and objectivity, they are neither.
The key factor in their ratings is a ‘measure’ of ideological belief (the belief that supporting a bank is the ‘best’ thing) and of the political will and brute power to enforce the decision. I put measure in quotes because it isn’t actually a measure at all. It is a guess of the political current. The problem is when that guess is incorporated into a rating on a bank it becomes a very powerful comment upon the political decisions and mood of an entire country. If the rating agency thinks the support uplift is solid the banks and their debt are boosted up and the bank gets a ‘good’ rating. If the political current seems to be ebbing away then the notches of support uplift is subtracted and the bank gets downgraded to a ‘bad’ rating.
The Rating Agencies have, by this means become a very powerful lobby group for a particular ideological and political commitment to bailing out the banks. If that is how we clearly understood their rating s I would have no problem with it. They would be like any other bank lobby group and think tank, trilling about how we must save the their clients. We would say to ourselves, “Well they would say that wouldn’t they” and weight their opinion accordingly. But the Ratings Agencies, the banks, the media and our governments have not been at pains to make sure we understand the real nature of what the Ratings Agencies do. They have been, it seems to me, rather happy to allow us to think the agencies offer objective scientific assessments as if they were ‘Which Bank” magazine.
They aren’t. I think they are far better seen as a sophisticated part of an aparatus for justifying and propping up the political and ideologial prejudices of the global financial class.
So when the Daiwa report conludes,
We don’t expect systemic support uplift to be entirely removed from the senior unsecured ratings of Europe’s biggest banks as they will remain so large and complex that governments are likely to be reluctant ultimately to subject them to the same resolution process as smaller, less systemically-important, institutions.
what I read is a concise summary of a political not a financial situation. To me it says, “The European political establishment can be counted on to let the banks remain too large to be controlled and thus continue to feed off the public purse for as long as the banks deem it necessary. “
Current levels of systemic support account for two to five notches of uplift for the large UK banks and one to five notches of uplift for the small to medium-sized financial institutions. Moody’s expects to retain a high level of systemic support uplift in the senior debt ratings of the major UK banks, as the rating agency believes that the regulators do not currently have all the tools necessary to resolve such institutions without causing financial instability.
“Do not currently have all the tools necessary” or ‘have been persuaded not to adopt them’? And the key to it all “…without casuing financial instability.” We don’t want financial instability do we? So systemic support uplift for the banks must be essential?
But is the support uplift we are ginving to the banks at our expense causing a greater financial instability? Moody’s doesn’t mention that. They don’t measure it either. So it does not appear in their ‘objective’ reports.
The ratings agencies are a paid and bought lobby group who work for the banks. Their job is to create spurious pseudo-scienctific justifications for what the banks want our governments to do.
An excellent exposé Golem!
As you demonstrate, there is no science to what the ratings agencies do. Using masses of historical data, Reinert & Rogoff’s “This time is different” proves that credit rating scores are the very worst predictor of sovereign default risk.
As a point in case, Iceland had a pretty top notch sovereign credit rating just up to the point it imploded.
As you say, this is not an objective and technocratic service they provide but a strong arm bullying technique serving certain power interests only.
Why aren’t the peddlers of this baloney hauled to account by the mainstream media?? The evidence for this is compelling!
– Hawkeye
Nice to hear from you Haweye. Hope you're well and happy.
Just thought I’d emphasise this point. The ratings agencies are not performing that most fundamental task which they are actually paid / presumed to be competent at – predicting default risk.
Having a category of “In default” is a bit like a fire prevention officer coming round to your house whilst it’s on fire and then giving his profound advice “I believe that your house is burning down”.
All of the Rating Agency assessments are provided as nothing more than a “rear view mirror” of what has happened in the past. There is not one iota of predictive capability in their overinflated egotistic little pen pushing activities! How does any sane person take them seriously????
Hi Golem
Yes, I'm doing well thanks – if we just ignore my rising blood pressure!
Sorry for being a bit quiet lately with holidays and courses and things.
Great to see some other Guest Posts on here lately! Will try and knuckle down for another post myself soon.
I hope Yorkshire has been sufficiently sunny!
– Hawkeye
Another post from you would be great. I thought about asking but didn't want to seem pushy.
Golem
Certainly not pushy. There's a few ideas germinating so I shall dust off my keyboard!
All the best,
– Hawkeye
Who will guard the guards and who pays them?
Next they'll be implementing a rating based on the stability of the banks CEOs marraige
It's pretty obvious the ratings are false prophets of profit given their predictions pre 2007; and, given nothing has changed since, other than an accelerating mix of the quagmire they are not going to jeopardize their income by blowing the gaff on their clients and stepping out of the box of frantic melee.
Though it has to be said, in the absence of any political will or backbone to fundamentally sort out the mess, they may consider these frantic antics have a chance of succeeding.
One way or another, while a god may bless this world – governments, politicians and moguls are turning a blessing into a penance.
One other thought on this topic — since support uplift rather directly relies on the solvency of the nation that is providing said support, when these scammers, er I mean rating "agencies", downgrade a nation's credit rating, does that downgrade the nation's banks support uplift "notches" as well? Its only logical to assume it would, but of course I'm sure it doesn't, as the "agencies" know their sovereign downgrades are political tools that bear little to no resemblance to the reality of sovereign risk. Once again the banksters get to have our cake and eat it too. The levels of deceit and falsity…
Yes.
But all who benefit from express fictional credit are in the same boat. The governments, the politicians, bankers, insurance companies, real estate, media that depend upon advertizing that comes with consumerism. Without credit, all are devastated. They are screwed this time, but look forward to a return to the good days.
Extend and pretend. TINA!
Depression is a much maligned condition! By the media, including academia!
This is the time of remedies. Massive credit will be created to keep the dream alive, as in ……. JAPAN.
Problem is, war is terribly easy as a way to cow the masses.
Franklin Fimbletonio,
Good morning and welcome. The realtion between support uplift and sovereign rating is th ekey, you're right. As far as I can see there isn't a step wise lnear relationship, but sovereign downgrades do reach a criticl thrershold after which the banks tumble because the nation is no longer in a positin to support them.
That is a large part of what is being played out in Europe at the moment.
I will be interested to see at what point we get the ratings agencies inviolved in rating the ECB and the EFSF.
I also wonder if there might not already be CDS contracts betting against the EFSF already in teh hands of teh very banks being bailed out by it. So that they can potentially win no matter what happens.
Good afternoon all
Another excellent article Golem (your site has been required reading for me for some time).
This is not strictly related to this thread, but I thought it was worth posting. The site below was mentioned in a post on a Guardian story today.
Excellent illustration of US national debt. If it wasn't true, it would be funny…
http://www.wtfnoway.com/
Chris
Vote of No Confidence: Deutsche Bank Dumps 70% of Spain, Portugal, Ireland, Greece, Italy Debt
Chris,
Thank you and thanks for the link.
CynicalHighlander,
Thanks for the link to Mish. I hadn't seen that. As he says – voting with their feet. It's the Landesbanks they should be worried about.
This is the fella who owns Standard & Poor, & quite a lot of everything else
http://en.wikipedia.org/wiki/Harold_W._McGraw_III
I got the link from this blog which I thought had some interesting details on it :-
http://www.thebellforum.com/showthread.php?t=54519&page=1
Seems he is also a knight of some kind of roundtable, who I don't think are much interested in chivalry.
Hi Golem
Just a quick mea culpa about the RBS blog as I was one who cited RBS as the mystery investors elsewhre. A small point but the gist was still true. I have to use a VIP to post from China sonot everything appears as it might to you.
Qyuick question? Was the Post Office account freeze just a computer glitch as reported or have they been moved. Just a question.
All the best. bill40
and here's more of what the ratings agencies do:
http://www.nakedcapitalism.com/2011/07/has-sp-become-our-rupert-murdoch.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29
bill,
You're on the right track. There is a story there I can't talk about it.
That is a good question Bill,
the Register thinks it was a computer glitch (a batch update gone wrong) http://www.theregister.co.uk/2011/07/27/post_office_counter_fail/
but this article in the Grocer a few days ago might point to other events
http://www.thegrocer.co.uk/articles.aspx?page=independentarticle&ID=219661
As a side issue, the Post Bank scheme was nothing at all like allowing RBS customers access their money in a PO
http://www.neweconomics.org/press-releases/new-coalition-launches-post-bank-campaign
Not watched this yet, as just stumbled across it:
Telegraph – Conflict of rating agencies
Is the Telegraph breaking ranks??
Piece on S&P's games in the US deficit debacle
http://www.nakedcapitalism.com/2011/07/has-sp-become-our-rupert-murdoch.html
I take all this more or less as read. We need politics to get us out of it, but we have none. Everyone must have noted our media have made a fuss over phone hacking almost as the News of the World would have done. We have almost nothing to cope with anything this serious. Still, I was in a meeting full of Soviet-watchers on the day the Berlin Wall fell. I was planning to help friends flee Bucharest at the time! Maybe something new could be closer than we think.
allcoppedout.
We sure as hell need something, we have a socialist party destroying Greece, a labour party assisting a centre/right party in ever tightening the screw on it's own people in Ireland, after a green party helped another right wing party to destroy the country. The UK has 3 slightly different flavours of the same shite, Obama is a total sell-out & there doesn't seem to be anything worth looking to anywhere else.
Thatcher could die now & be well pleased with her legacy.
I wish it were possible for me to be with these people.
http://roarmag.org/2011/07/syntagma-press-release-on-second-eu-bailout-agreement/
Fishing For Bankers
Depression will last for decades, not months or years!
The only way to prevent this and the next boom, is to reform credit and money. NOW! Across the world. This will be easier to accomplish in a decade or so…..
Says it all about the ratings that the US are still rated at AAA a couple of days before a potential default. Even if no agreement wouldn't trigger a default, its ludacris that they are rated the same as they were in 2003.
Also, whats the point of so many similarly named ratings. So you get downgraded from Aa3 to A1. Is that the dumbest system in the world, or like that to deliberately mislead normal people reading the papers.
If the ratings agencies don't downgrade the US now with the news of the rather shocking growth figures then we know it is a rigged game. Because even if a debt deal is reached how can the US sort out it's deficit without growth?
They're in a very tight spot. If they keep on spending they'll grow their deficit. If they cut they'll enter a deflationary spiral and that will – grow the deficit.
Either way it looks pretty bad. So the ratings agencies should be downgrading US debt right now anyway.
Things are NOT looking good globally. One has to wonder though if we'll see another repeat of the same old patterns of the game so far. So the US gets a last minute debt agreement. Then Bernanke announces due to dire growth, more QE. The banks and Wall St rejoice, 'the markets' shoot up again. Lots of money is made by a few. Europe agrees more public money to bail out the private banks, the markets celebrate – yeilds fall slightly – everything looks good.
But the whole thing will just turn to crap again, sooner or later, because nothing fundamental has changed or been addressed. i really am quite, quite frightened now for how this will play out.
"Could Iceland be a model for debt-ridden Europe?", asks a BBC correspondent: http://news.bbc.co.uk/1/hi/programmes/from_our_own_correspondent/9550667.stm .
Includes an interview with Icelandic president Olafur Ragnar Grimsson, who says listening to the credit ratings agencies was a mistake.
A step in the right direction ?
http://www.guardian.co.uk/politics/2011/jul/31/public-jury-campaign-feral-elite
Hi Golem,
Bit disappointed you haven't replied to or even aknowledged the emails I've sent you regarding MMT & positivemoney.org's monetary system reform proposals?
(Full reserve banking & MMT fiscal management)
http://www.positivemoney.org.uk/wp-content/uploads/2011/07/Submission-to-ICB-4-July-11-Positive-Money-nef-Soton-Uni1.pdf
A solution to the US debt ceiling (artificial 'crisis' along MMT principles is put forward here:
http://www.correntewire.com/beyond_the_debt_ceiling_the_30_trillion_plan_for_ending_borrowing_and_the_national_debt
Full explanation of why minting a $30T coin is not inflationary here:
http://neweconomicperspectives.blogspot.com/2011/08/coin-seignorage-and-inflation.html#comments
Professor Yamaguchi of Doshisha University, Kyoto, Japan has done extensive economic modelling comparing the present debt money (bankstas free lunch) system with what he terms a 'public money' system (essentially, again, full reserve & MMT), paper here:
http://www.monetary.org/yamaguchipaper.pdf
The approach of all these is offering a real solution to the banks' scams & public finance economic warfare.
MikeHall,
Sorry for not replying, Mike. Been a bad time. For what its worth MMT seems to me to be a large part of the solution.
No worries David. Hope whatever bad situation you're having can sort itself out.
I guess I'm very keen to see MMT/full reserve proposals get a good airing. They seem to have such transforming potential, I think if the public were aware of how easily things could be changed & how much better off we'd be, they would be absolutely outraged that authorities are sitting on their hands, allowing the banks to rule & letting so many suffer unneccesary hardship.
Best wishes
Thanks Mike,
I will write aboutv MMT soon, I promise, and add my little bit to the tide of opinion.
David
I look forward to that. As many others have commented, your writing on these topics has been excellent.
I don't know how much you've absorbed as yet about MMT? It's taken me a while, reading around a lot of blogs, to get to what I feel is now a good overview of the key points & arguments. I've not really found one single source that covers it in a thorough way accessible to a non trained economist.
So, partly for your benefit, and for the benefit of other interested readers here, there is one MMT blog that I would reccomend as a starting point. It is that of Prof Bill Mitchell, University of Newcastle, NSW, Australia, for his superb commentary from an MMT perspective on the recent 'manufactured' debt ceiling 'crisis' in the US.
In particular, I believe the commentary translates directly to the UK & the UK government's ideological choice of devastating & entirely unneccesary 'austerity' program. Several posts over the last weeks here:
http://bilbo.economicoutlook.net/blog/
Usefully, Prof Mitchell provides links in his pieces to further explanation of the concepts & principles covered in previous blogs.
Spanish translation available here:
http://toponium-es.blogspot.com/2011/08/lo-que-en-realidad-hacen-las-agencias.html
Thanks