3 February 2011. By David Caploe PhD, Chief Political Economist, EconomyWatch.com
among the MOST significant omissions was the role of the credit rating agencies, the supposed guardians of the integrity of the financial world.
So while it's no surprise, it's also disturbing to see how these alleged protectors of the "honor" and sanctity of global investment
are, in at least three current difficult instances, quite obviously making bad situations worse:
the decades-long stagnation in Japan;
financially desperate US states; and the
rampant socio-economic inequality fueling the people power movement now sweeping
the Arab world.
Simultaneously the most and least surprising is Standard & Poor's downgrading of Japanese sovereign debt.
What's not surprising is that Japan's debt is now being rated as being worth so little.
After all, it's been wallowing for more than 20 years in the same sort of TBTF banker-dominated mess
into which the US and EU have so eagerly thrown themselves in the aftermath of Black September 2008.
it seems a strange time to create even more problems for the "third leg" of the trilateral, if you will, developed world.
The rating agencies have their own bizarre motives, though, so who knows why they chose now to make this otherwise reasonable move --
apparently they don't care about how much they further tighten already grisly political economic knots.
But let's look at the dynamics of S.& P.'s decision to lower Japan's sovereign credit rating last week to AA- from AA.
That is three levels below the highest possible rating, and S.& P.’s first downgrade of Japanese government debt since 2002 --
which is what makes us wonder "why now ???",
given that Japan's economy has been in serious flatline since long before AND after that year.
With the lower grade, Japan’s debt rating is now on par with China’s,
which last year overtook Japan as the world’s second-largest economy, after the United States.
S.& P.’s move came just weeks after both it and its rival ratings agency, Moody’s, cautioned that
they might take a more negative stance on the United States --
which could be even MORE de-stabilizing, as we will see shortly.
The move highlighted just how deeply indebted many of the world’s developed economies are —
despite concerted efforts on the part of their governments to improve their balance sheets.
But by size, Japan’s ballooning deficit is an anomaly.
Japan’s liabilities will hit 204 percent of its gross domestic product this year,
overshadowing even the 137 percent for beleaguered Greece,
according to figures from the Organization for Economic Cooperation and Development.
S.& P., in downgrading Japan, warned that the Japanese government had no “coherent strategy” to address its ballooning deficit,
and that its already high debt burden was likely to continue to rise further than it had anticipated before the financial crisis.
A rapidly aging population is adding to the country’s woes,
raising the likelihood of increasing social security and pension obligations in the future.
All of which is true -- but it's been true for the past 20 years.
So why now ???
Well, pardon us for thinking conspiratorially, but we wonder if it has anything to do with the fact that
Japan is now governed by the long-time opposition center - left Democratic Party,
after some 55 years of rule by the right-wing Liberal Democrats [ LDP ].
Kaoru Yosano, Japan’s newly installed economy minister, said that the S.& P. move was “regrettable”.
Prime Minister Naoto Kan had little reassurance to offer.
“I just heard that news,” a flustered-looking Mr. Kan told reporters.
“I am a little ignorant on those kind of matters,” he said. “Let me look into it more.”
Well, that's definitely not reassuring -- but, again,
hardly different from the way the LDP had "managed" things since the 1989 collapse of the Tokyo real estate market.
Sound familiar ???
The United States, France, Germany and Britain are among major economies that retain AAA ratings,
although some investors suspect that they, too, may become more vulnerable
if growth slows anew or if their public finances fail to improve.
And since both of those conditions are more than likely to eventuate,
you have to wonder if these guys have any idea of the impact their strange "ratings" are going to have.
This month, Moody’s and S.& P. both warned that the AAA rating for the United States
could be reviewed in a couple of years if its debt kept growing.
A couple of years ???
That may seem reassuring -- until, that is, you read what's coming next.
But a downgrade appears unlikely as long as the United States economy and the dollar retain their global dominance.
Which indicates the extent to which their considerations are as much political as economic.
Meanwhile, the debt levels of several of Europe’s smaller economies on the periphery of the euro zone
have raised worries about possible defaults and more pain for the banking system.
Since the onset of the sovereign debt crisis in the euro zone early last year,
the main ratings agencies have downgraded the sovereign credit of a number of countries,
including Greece, Ireland, Spain, Portugal and Belgium.
John Lipsky, first deputy managing director of the International Monetary Fund, suggested S&P's action vis-a-vis Japan highlighted debt problems in developed countries.
“All the advanced economies face long-term fiscal challenges,” Mr. Lipsky said.
“These problems have been brought into focus by the crisis. These issues need to be addressed.”
Although we all know the POLITICAL dynamics throughout the developed world
mitigate AGAINST addressing any of these issues seriously.
Despite the staggering size of Japan’s debt-to-G.D.P. ratio,
most of Japan’s debt is held domestically, like India,
but unlike that of Greece or the United States.
And Japan runs a current-account surplus in trade, putting it on a more stable financial footing,
Japan’s borrowing costs still remain among the lowest in the industrialized world --
perhaps because it has had the same useless, counter-productive, TBTF banker-oriented
But as the S&P "rationale" re Japan indicates,
there are looming "rating agency" problems for the rest of the developed world, including the United States.
And some of them are a lot closer than looming -- indeed, they're already fast approaching in the US,
not yet for the Federal government, perhaps,
but for individual American states.
Financially Struggling US States
Moody’s Investors Service has begun to recalculate the states’ debt burdens in a way that includes unfunded pensions,
something states and others have ardently resisted until now.
States do not now show their pension obligations — funded or not — on their audited financial statements.
The board that issues accounting rules does not require them to.
And while it has been working on possible changes to the pension accounting rules,
investors have grown increasingly nervous about municipal bonds.
Moody’s new approach may now turn the tide in favor of more disclosure.
The ratings agency said that in the future,
it will add states’ unfunded pension obligations together with the value of their bonds,
and consider the totals when rating their credit.
The new approach will be more comparable to how the agency rates corporate debt and sovereign debt.
All of which is fine -- but one has to wonder why Moody's chose this particular time to weigh in on the issue of states' debt ???
It comes precisely when the question of under-funded public sector pension plans has become a MAJOR issue of political contention --
and their taking the position they seem to be espousing gives SIGNIFICANT "aid and comfort" to one side in the conflict,
namely, those who want to cut back on the existing contractual obligations of individual states to their employees,
and, indirectly, to attack the already-eroding power and influence of the public employee unions that gained those benefits for their members.
Moody’s did not indicate whether states’ credit ratings may rise or fall.
Under its new method, Moody’s found that the states with the biggest total indebtedness included
Connecticut, Hawaii, Illinois, Kentucky, Massachusetts, Mississippi, New Jersey and Rhode Island.
Puerto Rico also ranked high on the scale because its pension fund for public workers is so depleted
that it has virtually become a pay-as-you-go plan,
meaning each year’s payments to retirees are essentially coming out of the budget each year.
Other big states that have had trouble balancing their budgets lately, like New York and California, tended to fare better in the new rankings.
That is because Moody’s counted only the UN-funded portion of states’ pension obligations.
New York and California have tended to put more money into their state pension funds over the years,
so they have somewhat smaller shortfalls.
In the past, Moody’s looked at a state’s level of bonded debt alone when assessing its creditworthiness.
Pensions were considered “soft debt” and evaluated separately from the bonds, using a different method.
In making the change, Moody’s sidestepped a bitter, continuing debate
about whether states and cities were accurately measuring their total pension obligations in the first place.
In adding together the value of the states’ bonds and their unfunded pensions,
Moody’s is using the pension values reported by the states.
The shortfalls reported by the states greatly understate the scale of the problem,
according to a number of independent researchers.
Moody’s acknowledges the controversy, pointing out that
governments and corporations use very different methods to measure their total pension obligations.
The government method allows public pension funds to credit themselves
for the investment income, and the contributions, that they expect to receive in the future.
It has come under intense criticism since 2008 because the expected investment returns have not materialized.
Some states have not made the required contributions either.
Moody’s noted in its report that it was going to keep using the states’ own numbers,
but said that if they were calculated differently,
it “would likely lead to higher underfunded liabilities than are currently disclosed.”
After adding up the values of each state’s bonds and its unfunded pensions,
Moody’s compared the totals to each state’s available resources,
something it did in the past only for each state’s bonds.
It found that some relatively low-tax states, like Colorado and Illinois,
had very high total debts compared with their revenue,
suggesting that their finances could be improved by collecting more taxes.
But some states that are heavily indebted, like New Jersey, also have among the highest tax rates,
suggesting other types of action may be needed to reduce their debt burdens.
Moody’s was NOT suggesting any state was in such serious trouble it was about to default on its bonds,
something considered extremely unlikely by many analysts.
Some state officials have complained about the recent tendency to focus on total pension obligations,
calling it a scare tactic by union opponents who want to abolish traditional pensions
and make all state workers save for their own retirements.
A spokesman said Moody’s had decided it was important to consider total unfunded pension obligations
because they could contribute to current budget woes, according to this article in the New York Times.
A company with too much debt could close its doors, he said,
but governments do not have that option.
“They have a tax base. They have contractually obligated themselves to make these payments. These are part of the ongoing budget stress,” he said.
People Power in the Arab World
But budget stress is a relatively minor factor in the final area of global political economic tension
into which credit rating agencies have so dramatically thrust themselves:
the wave of popular demonstrations and "people power" now sweeping the Arab world,
known, at least for the moment, as the "Jasmine Revolution", its self-described name in Tunisia.
As the turmoil gripping much of the Arab world reaches a critical pitch in Egypt,
the possible economic fallout is on the minds of credit ratings agencies,
monitoring the situation from thousands of miles away,
who apparently don't like what they see.
But the warnings they themselves have issued have ALSO raised eyebrows.
Fitch Ratings said that it was putting a “negative” outlook on Egypt,
as protesters there clashed with security forces and defied curfews, raising questions about the country’s political stability.
That warning came on the heels of a report by Standard & Poor’s saying that the upheaval in Tunisia,
where mass protests drove the longtime president from office,
risked creating “downward ratings pressures” on other governments in the region,
if leaders tried to calm social unrest with “populist” spending on tax cuts, subsidies, and public sector jobs.
At the World Economic Forum in Davos, the agencies’ actions at such a sensitive moment set off alarm bells of their own.
“For a ratings agency that contributed to the recession, they seem to be getting it wrong again,”
said Kenneth Roth, the executive director of Human Rights Watch, which has several observers in Egypt.
Roth took issue with the assumption that maintaining the status quo was safest for investors:
“These unresponsive, brittle dictatorships are the last thing that the region needs to develop economically.
The Middle East is stagnating because it has had to operate economically under authoritarian governments.”
While the sovereign debt issued by countries in the affected region is already far from top-rated —
Fitch rates Egypt at BB+, near the risky end of the investment-grade range —
Timothy Garton Ash, a British historian and author, said in a separate interview that
raising the specter of a downgrade now was “ill-advised.”
“It poses the question that came out of the 2008 financial crisis:” he said,
although few organs other than EconomyWatch have consistently raised that question:
“What is the legitimacy of the ratings agencies? By whom are they authorized?”
The report by S. & P., issued last week, said that Egypt, Algeria, Jordan, and Morocco were vulnerable to political instability.
As governments in those countries, their finances already strained in many cases, move to calm public anger,
they may decide to step up spending on measures like public job programs and subsidized prices for staple foods and fuel —
and their credit ratings could suffer as a result, the agency said.
That would make it more expensive for the countries to borrow,
“Increased interest rates will mean less money for jobs and growth,”
said Moncef Cheikh-Rouhou of the HEC School of Management in Paris,
who was once a businessman in Tunisia and who has closely monitored the upheaval there.
In an interview at Davos, Mr. Cheikh-Rouhou urged
international investors to consider that “democracy is a good investment,”
and said that one of the most important elements to instilling democracy in a meaningful way
was job creation and investment in innovation.
and were trying to evade government efforts to cut them off from the Internet, he said,
showed that people in the region were well-educated,
and ready to contribute to social and economic stability.
“It will be easier for us to move toward growth
if we are richer and operating under democracy,
rather than under a dictatorship,” Mr. Cheikh-Rouhou said to the New York Times.
But apparently considerations like this are of relatively little interest
to the narrow-minded people who run credit rating agencies.
Their mandate to determine the hopes and dreams of people all over the world --
from Japan, to individual American states, to the newly awakening demonstrators of the Arab world --
remains as mysteriously il-legitimate as ever,
even as their power over people's lives grows ever stronger by the day.
David Caploe PhD
Chief Political Economist
President / acalaha.com