Wednesday, July 20, 2011

U.S. debt cut to AA+ from AAA

Egan-Jones cuts the U.S. debt from AAA to AA+ citing factors that move beyond the current political debate over how the debt ceiling will ultimately be raised!

Who is Egan-Jones and why should anyone care about what its analysts think?

Aren't we waiting for the decisive moves out of Fitch, S&P and Moody's?

Aren't their opinions the ones that really count when it comes to changes in the credit quality of an issuer?

If U.S. debt is still AAA according to them, then isn't that the bottom-line?

As proven in the past, the answer is unequivocally no!

There is an inherent conflict of interest and pay to play atmosphere surrounding Fitch, Moody's and S&P, created when it is a bond issuer who is paying the rating agency.

This system has the effect of causing the rating agencies to be reactive rather than proactive which, at the end of the day, provides absolutely no value-added to the public.

But because of their business model, that is the way that those firms need to conduct business in order to keep the bond issuers coming back to them for ratings the next time.

A downgrade of an issuer, no matter how justified it may be, would be bad for their business.

Therefore, a decision to downgrade would likely be delayed until it provided no benefit as it would have been long overdue.

So who is Egan-Jones again?

I will admit that until I read an article in the Financial Times, I had never heard of Egan-Jones either.

Egan-Jones has been recognized by the SEC (again this is no rousing endorsement) since 2008, but more importantly it only sells its analysis to institutional investors and does not sell ratings to issuers.

In other words, no conflict of interest.

So while this decision to cut U.S. debt to AA+ may not be coming from a firm that many would consider to be the gold standard of ratings, it is likely as valuable, if not more valuable, than the opinions coming out of Fitch, S&P and Moody's.

You remember that ratings triumvirate. The same people who slapped AAA's onto junk because of the dollars that were being slapped into their hands by the issuers!

Egan-Jones U.S. debt rating cut rationale

So what are the reasons for the rating cut of U.S. debt at this firm?

From FT,

"... Sean Egan, managing director of Egan-Jones, said that it classified the US rating outlook as “developing” and was looking beyond the current debt ceiling debate in Washington.

“We are watching to see what comes out of Washington, but will make a distinction between delinquency and an outright default,” he said.

Of greater concern for Egan-Jones is the rapid rise in outstanding debt and the prospect of retiring baby boomers severely straining social security and healthcare in the coming decade.

The agency said in its downgrade notice: “The major factor driving credit quality is the relatively high level of debt and the difficulty in significantly cutting spending...”

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