Exposing the Illusion: Are Ratings Agencies Spoiling the Show?

August 18, 2023

The key is getting people to look the wrong way.

In the world of magic it’s called “misdirection.”

Misdirection is the subtle art that cleverly diverts the audience’s attention, leaving them utterly enchanted, baffled, and awestruck all at once.

(Maybe that’s why many magicians have a “lovely assistant”…)

Every magician needs a lovely assistant…

Magic illusions aren’t really real. And they require some participation from those being fooled. Not necessarily active participation, but being just willing enough to look the other way when the deception begins.

It’s necessary to divert the audience’s attention so they don’t see what’s really happening on the stage.

And it’s not like the magician is doing anything wrong with their deceptions. People go to magic shows because they like to be fooled and amazed. 

Admit it… It’s way more enjoyable to witness the amazing and unbelievable, instead of knowing there’s a card up a sleeve or secret trap door…

And woe to any person who reveals an illusion’s secret in public. Sure, there might be a brief moment of satisfaction understanding what really happened. But after that, the magic is gone and crappy reality is all you’ve got left. 

This has been the US’ (and most of the world’s) economy for the better part of half a century. 

The financial magicians who “run” our economy have been misdirecting a willing public for over half a century. Of course the “willing” public participates because the illusion of prosperity is way better than the economic reality we live in.

In recent article, Michael Every global strategist at Rabobank stood up to be the guy who calls the magicians out:

If willing, start by recognizing the global economy has vast structural problems related to neoliberal financialisation and asset bubbles replacing physical production from the late 1970s until the Global Financial Crisis in 2008; then idiotic negative-rates-and-austerity can-kicking to bail out the rich; then a Covid lockdown and fiscal surge with no local supply chains; and now rapid rate hikes, which are straining global asset classes. The results have been simply awful.

We did it here in the Fake Economy

And now another group of naysayers have started to call out the government’s misdirection.

But does anybody care?

Uncle Sam’s Secret Revealed

Ratings agencies are supposed to determine the financial soundness of an investment. They were major participants in the misdirection before the big short in 2008 by rating trillions of dollars of junk as AAA. Their rationalization back then was “Well if we don’t rate this crap high, the company down the street will.” 

(They collect their fees from the financial group seeking the rating. So much for conflicts of interest!)

Lately it seems like they’ve come back to life. It was the beginning of August when they started calling out the secrets…

This has happened to the US before. In 2011 Standard & Poors downgraded US debt after another prolonged debt ceiling battle. The agency had warned Washington that it should aim to reduce the deficit by $4 trillion over 10 years. The most Congress could come up with was a deal to cut it by somewhere between $2.1 and $2.4 trillion.

The deal was signed August 2, 2011. 

S&P downgraded the US on August 5. 

This shot by Fitch came nearly two months after Congress passed their debt ceiling removal program. (Like they had to think about it for a while.)

Still their assessment was pretty stark (my emphasis)…

The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.

Naturally this wasn’t well received by those in financial power (i.e. the ones responsible for the downgrade). Treasury Secretary (former Fed Chair and lifetime Washington insider) Janet Yellen said she believed the downgrade was “entirely unwarranted” and waved her wand citing the standard economic magic words of falling inflation and low unemployment as proof. Then she added (again my emphasis):

She said Fitch’s “flawed assessment” was based on outdated data and failed to reflect improvements in U.S. governance indicators over the past two and a half years of President Joe Biden’s administration.

If you understand what “U.S. governance indicators” are, you’re smarter than me. Then, completely ignoring the rather blunt charge of “fiscal deterioration” levied against those in fiscal power, she ended with another flourish of misdirection…

“At the end of the day, Fitch’s decision does not change what all of us already know: that Treasury securities remain the world’s pre-eminent safe and liquid asset, and that the American economy is fundamentally strong.”

Hey… Look over there!

Another Illusion Shot Down

A week later Moody’s, another one of the big three, decided to get in on the action.

Moody’s lowered its rating of 10 regional banks (and warned that 17 more are in the crosshairs) saying the Fed’s struggle against inflation “continues to have a material impact on the US banking system’s funding and its economic capital.” The significantly higher rates by the Fed have put the banks’ bond holdings under water and left them with “sizeable unrealized losses.”

On top of that, the competition from money market funds (which are offering substantially higher returns) has started pushing costs higher and eating into profits. And…

“There remains a significant risk that systemwide deposits will resume their decline in coming quarters,” Moody’s said.

And they’re also vulnerable to the growing commercial real estate crisis that’s coming down the pike.

These were all the factors that caused the banking crisis in March this year which led to the second and third largest bank collapses in US history.

Not to worry though… At his May FOMC press conference Fed Chair Powell reached into his magic hat and opened his comments with:

Good afternoon. Before discussing today’s meeting, let me comment briefly on recent developments in the banking sector. Conditions in that sector have broadly improved since early March, and the U.S banking system is sound and resilient.

I rarely say this but I can predict with near 100% certainty that at the next FOMC press conference some reporter will ask about the downgrade and the words “sound” and “resilient” will be in Jerome’s answer.

(They’ll be setting up another Bank Term Funding Program just in case though…)

Look over there!

Pulling Back the Curtain on the Big Banks

This past week…

That’s one busy ratings agency.

On June 27, Fitch issued a report titled: U.S. Banks’ Operating Environment Score Lowered on Structural Challenges.

The “operating environment score” assesses the environment around banks’ ability to generate business while still operating within an acceptable level of risk. It’s not a reflection of any one bank. But it is one of the calculations that goes into generating a bank’s rating. According to the report, the lowered score reflected: 

…downward pressure on the U.S. sovereign rating, gaps in the regulatory framework and structural uncertainty around the normalization of monetary policy.

In other words, in their assessment, the banking industry’s financial health is straining.

The good news in this was that it didn’t force a downgrade. The bad news is the entire industry is on the bubble. According to Fitch Managing Director, Chris Wolfe:

“Another one-notch downgrade of the industry’s score, to A+ from AA-, would force Fitch to reevaluate ratings on each of the more than 70 US banks it covers.”

Currently the highest rated investment-grade banks are at AA-. Individual banks cannot have a rating higher than their operating environment score. So if, as Wolfe says, the operating environment deteriorates further, JP Morgan, BofA, BoNY and State Street Bank are all getting spanked. (As will pretty much the rest of the industry.)

The big question going forward in Fitch’s mind is how high will the Fed push interest rates? And how might higher rates impact loan defaults?

The big banks all took a hit after the news on Tuesday.

Jamie Dimon and the rest of his ilk performed a vanishing act when contacted for comment.

Clearly nothing to see here!

Ladies and Gentlemen!…

In 1918, performing in front of a packed house at New York’s Hippodrome Theater, Harry Houdini made a live elephant vanish on stage.

Houdini and Jennie — Now you see her…

In 2023 the magicians in Washington have materialized a booming economy…

Our economy has added more than 13 million jobs—including nearly 800,000 manufacturing jobs—and we’ve unleashed a manufacturing and clean energy boom. There were more than 10 million applications for new small businesses filed in 2021 and 2022—the strongest two years on record. America has seen the strongest growth since the pandemic of any leading economy in the world. Inflation has fallen for 11 straight months and has come down by more than half. And we have done it all while responsibly reducing the deficit.

None of this progress was an accident or inevitable—it has been a direct result of Bidenomics.

But now some observers are shouting out the secrets behind the illusions.

Will anybody care?

Learning the secret behind a magic trick can be exciting or disappointing depending on your perspective. But hearing these secrets called out should be a little unnerving…

Because the reality behind this trick is that in a financialized economy, borrowing without growth only feeds debt and inflation. It doesn’t create prosperity. It creates the illusion of prosperity covering over a lifetime of debt.

Not to worry though. There’s always another magic trick up their sleeve… 

The US can always print more money to service its debt and deficits…

Big banks will always step in to pick over the carcasses of failed smaller banks…

And the Fed will always find a way to bail out the big banks when they get in trouble… 

Is someone finally catching on to the fact that financializing an economy without actually producing anything of value has its limits?

At least someone’s calling out the misdirection…

Humbly yours,

Tim Collins
Editor, Streetlight Confidential