ED ’S SOAPBOX
away from the rulings on how much capital a bank should have, or on things like margin agreements. But Europe’s response is rather different. It’s not, in fact, a solution so much as a sidestepping process. The European Central Bank is discussing an idea whereby the shaky economies of Portugal, Ireland, Italy, Greece and Spain (the unflatteringly-named PIIGS), and all the others too, would be eligible for support from a new kind of so-called ‘eurobonds’ that would be jointly underwritten by all the Euro Club governments, and most of all by the ECB. Yes, that’s rather a radical solution. It implies that the credit pool will be underwritten by the whole vast Euro-zone economy, without regard to country risk. And that in
turn would make the need for approval from an outside ratings agency redundant. There are more radical mutterings in Europe, where pressure is growing for a panstate ratings agency that wouldn’t be a paid entity at all. During the last year Europeans have been outraged at the way Moody’s & Co launched blistering downgrades on Greece, Spain, Portugal and Italy - in each case, just in time to trash a major restructuring announcement. There have even been claims that the three American agencies are driving down the euro so as to make the embattled dollar look better. (Perish the thought.) An official ratings agency, some say, would obviate this problem nicely.
How does the scale system work? Ratings agencies haven’t altered their methods in the 150 years since they were first invented. A combination of intense mathematical study with ‘fingertip feel’ analysis – not to mention a lot of phoning your friends - results in a hybrid product which is, unfortunately, far too obscure for the average layman to tackle or contradict with any conviction. “Because everyone knows we’re good at it” is about the best account you’re going to get. Each of the ‘big three’ (S&P, Moody’s, Fitch) has its own classification system, which makes it hard to compare the ratings. But in very broad terms, the top of the quality spectrum is dominated by a group of what we normally call Triple A governments (or companies) – which at the time of writing included Britain, Germany and France. (Though France’s position was under review.) Because these governments’ debts are regarded as 100% secure, their Triple A rated bonds can get away with paying smaller yields than those of their slightly less distinguished competitors – which now include the AA+-rated United States, of course. That in turn means that the capital value of any triple-A bonds you hold is at a maximum.
www.IFAmagazine.com
It also means that any downgrade is going to wipe huge chunks off your bond portfolio! There’s nothing terribly bad about being an A anything, except that the yields are higher and the prices are consequently lower. Anything from BBB upwards (Standard & Poor’s) or Baa (Moody’s) qualifies as ‘investment grade’ and might be considered suitable for your pension portfolio. But ‘sub-investment’ grades which fail to make these levels are strictly for risk-takers in their various guises. Brazil opens the batting for government paper at BBB- from S&P, and Turkey and the Philippines score a mere BB. Ireland currently merits a Baa3, which is just above junk. There are hundreds of large companies on significantly lower ratings, and their high yields on their corporate bonds are reflected in sometimes large “spreads” over German bonds, a popular benchmark, or else against US Treasuries. Their prices are consequently lower to accommodate the risk of default, however small. Which is a good thing for an income investor or a risk investor, but a source of worry for those who insist on sleeping tightly. You pays your money and you takes your choice.
October 2011
25