The first ratings agency downgrade has occurred
Finally, it has happened as I and others predicted. Egan-Jones, a ratings company that, granted, is not one of the more prominent ones (e.g., Moody’s, Standard & Poor, and Fitch) has struck the first blow against the U.S’s pristine debt rating.
Egan-Jones announced yesterday that it had downgraded the U.S. debt rating, from AAA to AA+.
The company is less prominent than the larger agencies but to its credit, largely avoided buying into the collective subprime faux pas of its larger brethren.
The reason might be because it does not get paid by Wall Street banks whose securities it rates. This was the conflict of interest that led to S&P and others sanitizing worthless housing instruments
Egan-Jones instead collects fees from investors who need accurate assessments, so it has no dog in the fight and is motivated to provide accurate ratings to satisfy its customers. A Stanford University study said of the firm:
Credit ratings from Egan-Jones more accurately reflect information in the marketplace and are frequently up to 237 days ahead of actions taken by Moody’s and S&P.
The powerful market incentives resulting from the investor supported, independent business model of Egan-Jones Ratings Company produces more timely and accurate ratings with predictive value.
Serious investors would therefore be wise to take their ratings more seriously than the largest ratings firms. Egan-Jones states that it is not the fear of U.S. default that drove their ratings downgrade, but the concern that Washington won’t reduce the long-term deficit.
“The major factor driving credit quality is the relatively high level of debt and the difficulty in significantly cutting spending,” the firm said in a report released on Saturday.
The company’s view is therefore that the ability of the United States to to pay its debt is significantly diminished due to its long-term debt problem and the inability of the political system to solve the problem.
Therefore the major question now is whether the other ratings agencies, who’s ratings tend to eventually converge around Egan and Jones (according to a Federal Reserve study), will similarly downgrade any time soon. If they do, hold on to your hats, the ride may get quite bumpy.
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