Over the past few months, I am always amazed when I see how the world's major bond ratings agencies view the current level of sovereign debt. In particular, I have been shocked that the debt wall facing the United States has garnered very little in the way of a downgrade, perhaps a slap on the fingers with a wet spaghetti noodle at most. Thus far, the downgrade and warning have provided very little impetus for Congress and the President to meaningfully change their spend more and then tax less philosophy.
Fortunately, however, there is a very small ratings agency located in Jupiter, Florida, that takes a far more pragmatic view of America's debt problems. Weiss Ratings, an independent ratings agency, uses far tougher standards than other ratings agencies because they are primarily a consumer oriented agency, providing risk-adverse consumers with a means to better understand investment risk. They have a reputation as a very conservative ratings agency and use a different letter grading system that is more intuitive than a series of A's, B's and plus and minus signs. Weiss rates banks, insurance companies, and credit unions so that consumers can avoid depositing their hard-earned money with companies that are financially weak. Fortunately, Weiss also rates sovereign debt, the subject of this posting.
Here is a screen capture showing how Weiss's ratings scheme compares to Best, S&P, Moody's and Fitch:
As I mentioned before, Weiss's ratings scheme is far more intuitive since most of us passed through elementary school at one time or another and have very clear memories that E's and F's were very bad and were probably going to get grounded, D's weren't so hot, C's meant you had some problems that would require extra homework and A's and B's meant that you were doing well.
Here is a screen capture showing what Weiss's ratings mean:
Now let's get down to the specifics of Weiss's ratings for sovereign debt. Weiss analyzes data from the IMF and other government sources to determine a country's rating. They look at four factors:
1.) Debt Index: The debt index measures the country's reliance on debt and deficit financing in proportion to its population and the overall size of its economy.
2.) Stability Index: The stability index measure the country's strength in terms of its currency, reserves, status as a world reserve currency and default history.
3.) Macroeconomic Index: The macroeconomic index measures the long-term sustainability of the economy including GDP growth, unemployment and inflation.
4.) Market Acceptance Index: The market acceptance index measures the ability of the government to raise additional debt on the world's bond markets.
Here are their ratings for sovereign debt:
A - Excellent - The country's finances are in excellent shape with good budgetary and debt management. It has a strong economy with good ability to raise additional funds in global markets as required. Risks to bondholders relate to interest rate and exchange rate fluctuations only.
B - Very Good - The country's finances are in good shape with at least good scores in all four factors. Most risks to investors involve interest rate and exchange rate fluctuations as noted above.
C - Fair - The country's finances are in fair condition although in the event of adverse economic conditions, it may encounter difficulties in maintaining its financial stability. Investors in bonds from these countries face potential losses if there are sustained declines in the country's medium- or long-term government securities that exceed those that are strictly related to rising inflation. Losses could also be incurred from a serious decline in a nation's currency.
D - Weak - The country is in a weakened financial condition with poor results on at least one of the four factors. It could have a heavy debt load, inadequate reserves, poor economic growth or an inability to raise additional funds on the world's bond markets. Risk to investors includes the threat of default. Sovereign debt investments in C-rated countries should be considered speculative.
E - Very Weak - The country has very severe financial weaknesses that make investment in its securities highly risky. Investors face very high risk of loss of investment capital because of bond price declines, currency collapses or default. Sovereign debt investments in D-rated countries should be considered extremely speculative.
That's enough background. Now let's look at what Weiss has to say about the United States and Canada.
1.) United States: To open, Weiss quite clearly states that they are not big fans of the AAA ratings assigned by the major ratings houses to United States sovereign debt. Here is a quote:
"We believe that the AAA/Aaa assigned to U.S. sovereign debt by Standard & Poor’s (S&P), Moody’s and Fitch is unfair to investors and savers, who are undercompensated for the risks they are taking. An honest rating for U.S. government debt is urgently needed to help protect investors and support the collective sacrifices the U.S. must make in order to restore its finances."
Weiss definitely does not go out of its way to be kind to the United States. They rate United States' sovereign debt as meriting a grade of C, putting them in 44th place out of 47 nations in terms of its debt burden primarily because of its consistently large deficits, 32nd place for its international stability due to its low reserves, 27th place for economic growth because of the swings in its economic growth pattern and 6th place for its ability to borrow in the international bond marketplace, largely because the United States dollar is regarded as the world's reserve currency. Overall, the United States comes in 33rd place out of the 47 nations in Weiss's ratings "world".
Here is Weiss's summary of their reasoning behind their assessment:
"The C rating signals that the current fiscal condition of the United States government is far inferior to that implied by its AAA/Aaa rating from other agencies. At the same time, it means that the U.S. retains enough borrowing power in the marketplace to give it the opportunity to take remedial steps. Still, there are grave risks for policymakers and investors, including the possibility of a vicious cycle that includes severe declines in U.S. bond prices and the U.S. dollar.
Although our opinion of U.S. sovereign debt contradicts the AAA/Aaa rating assigned by the U.S. credit rating agencies, it is supported by a large body of new research published by governmental and international organizations. Moreover, in creating its sovereign debt ratings, Weiss Ratings ensures fairness by avoiding conflicts of interest and focusing exclusively on objective, quantifiable criteria without cultural or political bias."
Weiss feels that the AAA/Aaa ratings assigned to United States sovereign debt securities is misleading investors because it fails to warn investors of the true risk involved, meaning that investors are undercompensated for the risk that they are taking when holding United States Treasuries. Most importantly, Weiss also notes that:
"The AAA/Aaa U.S. debt rating has continually fostered political resistance and gridlock in Washington. If an appropriate rating had been issued years ago, it could have played a pivotal role in helping lawmakers and policymakers take earlier remedial steps." (my bold)
Perhaps Weiss is correct; until there is a meaningful downgrade in the rating of United States sovereign debt, action on the part of Washington will not be forthcoming. After all, until you are punished, you have no incentive to change your behaviour! One need look no further than the recent example of the Eurozone to see what has happened when the major ratings agencies downgraded the debts of several European nations by several steps at a time. Certainly, the Eurozone's problems are far from over but at least discussions are being held and modest headway is being made. The same cannot be said for the United States where vitriolic partisan politicking takes the place of meaningful fiscal change.
2.) Canada: Weiss downgraded Canada from C to C- on December 19th, 2011. Weiss states that Canada is expecting slower-than-expected economic growth and rising unemployment which will make it increasingly difficult for Canada's government to balance its budget. As well, due to close economic ties with the United States and Europe, Canada is in the line-of-fire and cannot possibly hope to sidestep the world economic slowdown as it relates to the Eurozone debt crisis. Weiss also notes that reduced government receipts will make it difficult to achieve fiscal balance. This assessment is not that far off from what Canada's Parliamentary Budget Officer noted in his appraisal of Canada's chances of fiscal balance in his most recent PBO Economic and Fiscal Outook in November 2011.
To put these ratings into perspective, Weiss rates Austria as a C+, Belgium as a C-, the United Kingdom as a C-, Turkey as a C-, Ireland as a D-, Spain as a D+, Portugal as a D+, Brazil as a C, Greece as an E and Australia as a C+. Austria, Belgium and Turkey have all noted declines in their ratings in recent months due to deteriorating conditions in the stability of their financial markets. It is interesting to see Canada and the United States dwelling in the Eurozone debt transgressors neighbourhood, isn't it? Weiss's A-rated nations include Switzerland, Singapore, China and Malaysia.
As a hobby economist, I really like the Weiss ratings system. Not only is it easier to understand for lay people, I think that it better reflects the true situation of the fiscal stability of both Canada and the United States. While the governments of both nations just love to strut about and proclaim that their debt has among the world's highest credit ratings, their grasp on reality is tenuous at best. Weiss's grasp of the real issues that will ultimately impact the creditworthiness of nations seems to be far more compelling. After all, one cannot go on making a dollar and spending a two dollars forever. The folks at Weiss seem to be aware of that fact. Unfortunately, our politicians do not.