How Unreliable Are S&P Ratings?

by Pejman Yousefzadeh on August 7, 2011

This unreliable:

The graph above shows the relationship between sovereign debt levels, and S&P ratings. As Charles Franklin, the author of the post points out:

The most immediate and useful result is that there is very little relationship between S&P rating and the median debt level in each rating group. If debt were the primary element of the ratings, we would expect to see the red median markers move up from left to right. In fact there is almost no systematic pattern in the medians across groups.

Again, we have to live with the existence of the ratings agencies, and we have to contend with the power that they wield. But nothing justifies remaining silent when their ratings systems don’t make any sense whatsoever. There may be a political component to belittling S&P’s methodology–in the aftermath of their downgrade of our credit rating, we really don’t want their opinion to matter all that much, so that we can bring some calm to the markets, and so that we don’t have to pay higher interest rates–but that doesn’t mean that S&P’s methodology doesn’t leave a whole lot to be desired.

(Thanks to John Sides for the link.)

  • Michael Fisk

    It would also be noted that the United States has a higher debt-to-GDP ratio than any country with a AAA rating, and it appears as though the political will to address the situation is conspicuously absent.  Assuming a worst case, but not unrealistic, scenario (2% average growth and additional deficits of $10 trillion over the next decade), US debt to GDP would stand at about 140%, putting it roughly in the same category as Greece.  While high demand for Treasuries will keep interest rates down (and thereby minimizing any risk of obligations not being met), I don’t see how the fundamentals could justify a maintaining of a AAA rating, and future spending on entitlements make the guidance going forward even worse.  Is the timing of the downgrade suspect?  Absolutely.  But all that means from my perspective is that it’s a shock that somebody didn’t downgrade Treasuries sooner, and possibly further (AA or AA- does not seem like a stretch).

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