Where does the US credit rating come from?
Where does the US credit rating come from?
Wednesday night, the credit ratings agency Fitch announced that it put its credit rating for the United states on “watch negative,” meaning that its AAA credit rating is at risk because of “debt ceiling brinksmanship.” In 2011, when Congress had another standoff over the debt limit, ratings agency S&P downgraded the United States from AAA to AA+ for the first time.
As we approach the X-date without a deal, “Marketplace” host Kai Ryssdal spoke with Atsi Sheth, a managing director and global head of credit strategy and research at Moody’s Investors Service, about their credit ratings process. Along with S&P and Fitch, Moody’s is a member of the “big three” credit rating agencies. The following is an edited transcript of their conversation.
Kai Ryssdal: In the most basic layperson terms, could you help us understand why we have credit ratings?
Atsi Sheth: Sure. So in the most basic terms, a credit rating is really an opinion on the credit quality of any entity that borrows on the debt capital markets. And what the rating does is tells any investor that wants to invest in that entity, how relatively risky that entity is. And we tell them this through a rating scale with AAA being the least risky, and C at the bottom of the scale being highly risky and likely to be in default very soon.
Ryssdal: OK. Now, nuts and bolts on the inside, how does it work? You, I imagine, have many rooms full of people generating the material by which these opinions these credit ratings get issued?
Sheth: Sure. So you know, the company that I work for has been doing this for about 100 years. And what we’ve learned is that there are certain things that determine your level of risk as a debt issuer. If you’re an auto company, there’s a whole set of aspects that define what will make you more or less risky. If you’re a country, there’s a different set of methodologies. That’s the analytic framework. Then, we have people that monitor each entity that we rate on a daily basis, and when they see something that’s happening in that entity’s — if it’s a company, on their balance sheet or their profits — that might change their credit worthiness. We have a rating committee. It’s people that come from all over the world that are experts in that particular sector, and they discuss and we provide a rating after that.
Ryssdal: So do you all just get on some giant Zoom and discuss the credit worthiness of I don’t know, the Ford Motor Company or the Acme Widget Company or oh, just for instance, the United States of America?
Sheth: We do indeed. And before Zoom, we did that on the telephone. But Zoom makes it much easier.
Ryssdal: I imagine there’s a lot of body language that goes into this.
Sheth: Indeed. And these are very robust discussions. What we want is a lot of different opinions coming in so that the rating that we finally put out really reflects a range of views and is really robust to all kinds of challenges and things that the entity might face.
Ryssdal: OK, so, to the news, right: There was the news from Fitch last night about the United States and how it’s thinking about things. And obviously, I don’t expect you to deliver on this program — unless you would care to — a comment on the downgrade of American debt. But how are you thinking about all of that?
Sheth: Sure. You know, the one word that I’d emphasize in terms of ratings is that they are a relative assessment of credit risk. So we rate the United States at AAA. And this means that we do not believe that there is a high risk; in fact, we believe there is the lowest risk. This is, you know, a huge economy — very dynamic. It has the wherewithal to repay debt. The reason we’re talking about credit risk now, or default rates now, is the debt ceiling. Our view is that this will be a very, very noisy process, but in the end, Congress will come together such that the U.S. and the Treasury will be able to make their debt payments.
Ryssdal: What you’re saying is that they’re gonna fix it, because they have to, as opposed to reading the politics of this situation.
Sheth: No, I would say the politics are very, very important. The politics are what makes it so noisy. So you know, you’ve had the debt limit in place, you know, for almost 100 years, you know, more than, but it has gotten more and more noisy and more contentious as politics have become more polarized. And that is indeed a risk. What we do think is, one, it’s been noisy. Sometimes we’ve gone down to the wire, but ultimately, a solution has been found. So that’s one track record. The second, we do believe that there’s a recognition among politicians who disagree on almost everything or many, many things, but they do agree that a debt default would be very, very painful for their constituents.
Ryssdal: As long as we’re on that, and since you’re the trained observer in this conversation, how painful?
Sheth: Well, in a number of ways. So if we come to June 1 without an agreement in place, the Treasury might have to decide to make certain payments and not others. We expect debt payments to be those certain payments. But the ones that are not paid will hurt the individuals or households or companies that are not paid. It’ll hurt them. In the event of a default — which again, I should reiterate, we don’t expect —financial markets would become so volatile. And because this has never happened, it’s very hard to predict what that would mean for interest rates, for the dollar, for liquidity. And that would just have wide ranging effects even to people who are not owed any money from the government.
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