February 23, 2024

Economix: Should You Worry About a U.S. Default?

Carmen M. Reinhart says ratings agencies have a poor track record in predicting financial crises.Mary F. Calvert for The New York Times Carmen M. Reinhart says ratings agencies have a poor track record in predicting financial crises.

Standard Poor’s, the ratings agency, lowered its outlook for the United States to “negative” on Monday, a warning that the country’s top-notch, triple-A credit rating may be lowered. Credit ratings are supposed to give crucial insight into a debtor’s likelihood of default, so a lot of investors and pundits made a big deal about this announcement.

Given the lackluster job that S.P. and other agencies did in rating mortgage-backed securities before the financial crisis, some critics have questioned the relevance of the agency’s latest pronouncement. But the toxic-assets track record aside, there are other reasons to discount this latest S.P. call.

In a recent interview, the financial crisis historian Carmen M. Reinhart said that ratings agencies had historically done a poor job at predicting sovereign debt defaults, currency collapses and other financial crises.

That is because, as she wrote in her paper, “Default, Currency Crises, and Sovereign Credit Ratings,” ratings agencies — like so many other professional forecasters — tend to focus on the wrong variables in calculating their ratings. In other words, S.P.’s announcement may not actually tell us very much.

Whatever the historical record of ratings agencies, markets nonetheless reacted strongly. And today the Obama administration has come out in full force to reassure investors.

As my colleague Christine Hauser wrote, Treasury Secretary Timothy F. Geithner tried to soothe foreign investors who might be concerned about the security of United States debt.

Mr. Geithner offered the following words of comfort: “Look at the price at which we borrow.” In other words, don’t worry, because interest rates are still joyously low.

But run this observation by economic historians, and you will find that it also provides little assurance.

In other research Professor Reinhart has found that that interest rates are surprisingly bad at predicting debt crises in the near future. The painful rise in the cost of borrowing that is typical in a sovereign debt crisis often comes on extremely suddenly, Professor Reinhart says. (After all, the assumption that just because things have been trending a certain way for a long while means they will stay that way forever is exactly the kind of logic that led to the housing bubble.)

In other words, there are a lot of things to pay attention to when you are trying to predict whether the United States is likely to default. Unfortunately, despite what you may have read lately and seen in the markets, sovereign credit ratings and current interest rates may not actually lend you that much insight.

Article source: http://feeds.nytimes.com/click.phdo?i=18d107a88d1f7e29f1d4bd3f85acb0a0

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