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Standard & Poor's cut its credit outlook on the US to negative

On Monday, April 18th, Standard and Poors, a Nationally Recognized Statistical Rating Organization (NRSRO), or credit rating agency, cut its credit outlook for the US to negative. We believe this rating opinion unwarranted and inaccurate. To understand why, one must look at credit rating agencies in general, their competence (specifically, their performance prior to the recent financial crisis), and current AAA rated countries.

Lets take that last item first. Here is the list of countries currently rated AAA by S&P:
  • Australia
  • Austria
  • Canada
  • Denmark
  • Finland
  • France
  • Germany
  • Guernsey
  • Hong Kong
  • Isle of Man
  • Liechtenstein
  • Netherlands
  • New Zealand
  • Singapore
  • Sweden
  • United Kingdom
  • United States of America
We find it difficult to believe that the Isle of Man and Liechtenstein, countries whose main export appears to be laundered money, will be better future credit risks than the United States of America.

Let's next review what a credit rating agency is, what it does and how it makes money. According to one source, "In the United States, the Securities and Exchange Commission (SEC) permits investment banks and broker-dealers to use credit ratings from 'Nationally Recognized Statistical Rating Organizations' (or 'NRSROs').. for regulatory purposes..SEC regulations require that money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but without FDIC insurance) (hold) only securities with a very high NRSRO rating. Likewise, (banking and) insurance regulators use credit ratings to ascertain the strength of the reserves held by (banks and) insurance companies."

In other words, the SEC, the agency that selects companies that can be recognized as credit rating agencies or use the NRSRO designation, tells institutional investors that they can only hold securities that are rated by these same NRSRO's.

The competence of the credit rating agencies is suspect: they made multiple, serious and significant errors in rating securities issued by Enron, Worldcom, Lehman Brothers, Bear Sterns, and hundreds of others, rating these securities safe until, in many cases, the day before the issuer defaulted. These institutions are supposed to “base their ratings largely on statistical calculations of a borrower's likelihood of default,” but one news report noted that:

“Dozens of current and former rating officials, financial advisers and Wall Street traders and investors interviewed by The Washington Post say the (NRSRO) rating system has proved so dominant they can keep their rating processes secret, force clients to pay higher fees and fend off complaints about their mistakes."

On a positive note, it is our belief that S&P's revised credit outlook can be used as a reason to raise taxes, to specifically repeal the Bush tax cuts.

This is, in our opinion, the most rational way to solve the so-called budget crisis.

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