Standard & Poor’s, also known as S&P, is a Mc Graw Hill division company that amongst other things provides ratings for a host of financial products and systems. Ratings are there to serve as a guideline indicating the expected performance and stability of a particular financial package/ system.
The higher the rating, the higher a financial package is expected to perform and as such will attract more investment. Lower ratings means poor performance is expected and as such will make investors wary and in the case of governments will attract higher fees when it comes to borrowing money.
Recently, S&P have downgraded Malta’s rating from A to A- along with a number of other EU countries in the face of the ongoing crisis. This segment is referred to as Sovereigns and the highest rating awarded by S&P in this segment (and any other segment for that matter) is AAA.
A bit of (recent) history…
The early 2000s saw the introduction of the Securitization Food Chain. In this new system, banks giving out loans were no longer concerned about those loans being paid back. This was because loans were sold to Investment Banks who packaged these loans into a derivative called a CDO – Collateralized Debt Obligation (a collection of consumer debts). These CDOs where then sold to investors; in some cases retirement funds and people investing their life savings.
Now the banks, instead of making money on loan repayments, made money on the number of loans it sold to Investment Banks. This of course led the banks to give out loans, in some cases, in many cases, to people who could never repay them. The number of loans issued out in fact quadrupled over the span of a few years. In very broad terms, 3 in every 4 loans issued would not have been granted had the banks expected to make money off the payments they received.
When the rating agencies were asked to rate these CDOs, guess what they got? AAA – an extremely strong capacity to meet their financial obligations.
Needless to say these CDOs flopped, wiping trillions of dollars off the books and bringing about the recession we faced in 2008.
So when S&P rate something, it means poop. Of course, banks (the ones that are still in business and have some sort of balance sheet that is not in the red) still heed rating agencies and as such we will incur more fees when borrowing money. However, do not take this as a sign of the government’s poor performance because had we given loans to unemployed people and then sold those loans to Investment Banks, we would have got a pat on the back.
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