Greek Debt Ratings

Moody’s has downgraded its rating on Greek sovereign debt:

Greece debt rating cut further by Moody’s

Moody’s has downgraded Greece’s debt to “highly speculative” prompting an angry response from the finance ministry. Greek bonds fell after the rating agency cut its rating from Ba1 to B1.

Moody’s cited “endemic tax evasion”, “very ambitious” austerity plans, and the possibility that the EU may force a debt restructuring on Greece after 2013 as reasons for its decision.

Greece’s finance ministry said the move was “incomprehensible” and called for tighter regulation of rating agencies.

“Ultimately, Moody’s downgrading of Greece’s debts reveals more about the misaligned incentives and the lack of accountability of credit rating agencies than the genuine state or prospects of the Greek economy,” said the Greek finance ministry in a statement.

“Having completely missed the build-up of risk that led to the global financial crisis in 2008, the rating agencies are now competing with each other to be the first to identify risks that will lead to the next crisis.”

I have to say, I agree completely with the sentiments expressed here by the Greek finance ministry. In my mind, the credit rating downgrades have become a lagging indicator of problems, and have demonstrated little or no predictive power. Take a look at the chart below.

The blue line shows the interest rate spread on long-term Greek government bonds over the equivalent bonds issued by the German government. The other two lines show the ratings assigned to Greek sovereign debt by S&P and Moody’s since January 2008, normalized so that they’re on the same scale.

The question I ask myself is this: would paying attention to ratings have helped me make (or save) any money on Greek debt? If we assume that the market is charging the Greek bonds a higher interest rate to compensate for the higher chance that the Greek government will default, then the interest rate spread is a rough measure of the market’s estimation of the likelihood of Greek government default. The market seems to pay little attention to credit ratings, and if I had used the credit ratings as a cue to buy or sell Greek government bonds, I can’t see that it would have provided me with any benefit.

But this has become completely typical of credit ratings in recent years – just think about how badly they mis-rated a giant swathe of assets leading up to the financial crisis of 2008. All in all, I’m not quite sure why we should care about what rating Moody’s and S&P assign to Greece’s sovereign debts – or any other debt, for that matter.