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The old joke is that actuaries make accountants look interesting. Now that Fitch wants to play politics, financial rating agencies are making even political pollsters look credible. Right now, there is no fiscal crisis to catalyze a downgrade amidst a resurgent Bidenomics-fueled economy, with inflation coming down, record-low unemployment, strong GDP growth, exuberant stock markets, and a renaissance in domestic manufacturing. There is now speculation that Fitch’s downgrade may have been driven more by self-aggrandizement with the Fitch sovereign debt team getting their 15 minutes of fame or perhaps even by an implicit pro-Trump bias.
By downgrading the creditworthiness of U.S. sovereign debt almost immediately after former President Trump’s indictment, and by sadly doubling down on a bad hand by downgrading U.S. government-adjacent institutions such as Fannie Mae and Freddie Mac, Fitch is quickly becoming a widely lampooned joke across the business community. CNBC host Jim Cramer laughed, “They know nothing,” while venerated JPMorgan CEO Jamie Dimon decried Fitch’s move, arguing that “to have other countries be triple-A and not America is ridiculous. It’s still the most prosperous nation on the planet, it’s the most secure nation on the planet”.
Similarly, economist Mohamed El-Erian was left scratching his head. “I am very puzzled by many aspects of Fitch’s announcement, as well as by the timing, and the vast majority of economists and market analysts looking at this are likely to be equally perplexed,” he tweeted. Meanwhile, Nobel laureate economist Paul Krugman tweeted, “Fitch’s decision doesn’t make sense even on their own stated criteria, and is widely and correctly ridiculed.” Even Warren Buffett chimed in. “There are some things people shouldn’t worry about. This is one,” the investment luminary said.
A suspicious timing
Fitch’s grandstanding was similarly dismissed by politicos and economic policy voices on both sides of the aisle in DC–where Fitch pulled off the hard accomplishment of simultaneously angering Democrats and Republicans. Harvard’s Jason Furman dismissed the move as “completely absurd and likely to show that Fitch is irrelevant.” Normally mild-mannered Treasury Secretary Janet Yellen was uncharacteristically strident in slamming Fitch’s move as “flawed and entirely unwarranted.” Some GOP voices joined in the chorus, such as Congressman Blaine Luetkemeyer, who rightly expressed “concerns about Fitch’s history of subjective ratings changes.”
Competitors gleefully jumped in. “Fitch’s downgrade of U.S. debt if off-base. Ask global investors whose bonds they would rather own if push comes to shove in the global economy–it’s those of the U.S. Treasury,” Moody’s chief economist Mark Zandi jabbed.
All of these respected voices are struggling to see any sense in Fitch’s capricious downgrade. Fitch’s head of sovereign ratings meekly pointed to “political dysfunction, rising deficits, and government debt” to justify the suspicious timing of the downgrade–ignoring that the increase in debt was far larger under the previous administration–and that the Biden Administration has reduced the deficit by a record $1.7 trillion.
And of course, downgrading the debt due to political dysfunction three years after the Jan. 6 insurrection is akin to “punishing the cleanup crew when the guy who wrecked the room is long gone,” as CEA Chair Jared Bernstein pithily put it.
Ironically, the CEO of Fitch, Paul Taylor, was previously the global head of structured finance ratings, an epicenter of the 2008 Global Financial Crisis. Some might say it’s akin to putting the guy who fumbled the Bay of Pigs invasion in charge of the CIA. Taylor, an undergraduate marketing major, is not an economist, accountant, or government official by training.
A spotty track record
Regardless, markets have no reason to be spooked by Fitch’s downgrade. A review of the rating agencies’ track record suggests that they are not very good at their raison d’être: giving ratings. They have collectively failed to predict virtually every genuine default across both sovereign governments and corporate borrowers in the last five decades while predicting many defaults that did not actually happen.
This ineptitude has been shown by study after study. On the sovereign debt side, Harvard economist Carmen Rinehart has found that the rating agencies missed almost every major economic crisis preceding global sovereign defaults, including the 1980s Latin American debt crisis, the 1997 Asian financial crisis, the global financial crisis of 2008, and the 2010s European debt crises. On the flip side, in the early days after COVID, Fitch downgraded a whopping 29 countries into the lowest ratings categories in the first four months of 2020–but less than a quarter of those actually ended up defaulting.
The record of rating agencies on the corporate side is even more abysmal, as we have written about for decades. As the first author pointed out in 2002, the major ratings agencies–Fitch, Standard & Poor’s, and Moody’s–downgraded WorldCom to junk status only after the board lost confidence in CEO Bernard Ebbers and forced his resignation, one month before its final collapse and well after the company had already begun its death spiral.
Perhaps some of the rating firms may not have wanted to see any trouble even though the evidence was in plain sight; after all, the chairman of Moody’s Board at the time, Clifford Alexander, was concurrently a sitting, 19-year board member of WorldCom, and Moody’s continued to rate WorldCom debt highly even when bond traders were correctly trading WorldCom debt at high levels.
Similarly, as the first author pointed out the previous year in 2001, the rating firms refused to downgrade Enron even when Enron bonds fell to junk prices amidst blatant pressure from conflicted executives and customers, only folding when Enron had lost all of its customers, all potential acquirers, and all of its lifelines. And the rating agencies only cut Tyco to junk status after its disgraced CEO Dennis Kozlowski resigned and was indicted on criminal charges. More recently, all the rating agencies failed to foresee the collapse of Silicon Valley Bank despite “obvious” bond portfolio losses amidst rising interest rates–which were apparently not obvious until they were.
The track record of the rating firms becomes even more disappointing when it gets to more complicated financial instruments, such as the complicated mortgage-backed securities that helped produce the Great Financial Crisis in 2008. As chronicled by Michael Lewis’ The Big Short, the rating firms slapped high grades on tranches of junk mortgages from subprime borrowers, inadvertently creating “financial weapons of mass destruction,” which almost brought down the entire financial system.
These prominent misses do not even account for many other systemic critiques of ratings agencies–ranging from their implicit blessing of the practice of “rating shopping” as companies bring their business and money to the rating firm that offers the highest ratings, to flawed and excessively mechanic methodologies, to regulatory capture, with the government setting capital requirements of U.S. financial institutions inexplicably dependent upon the ratings of the securities they hold, instead of more objective measuring sticks such as market prices and spreads.
Many also castigate industry bias. For example, rating firms are seen to be excessively harsh on cyclical, capital-intensive industries such as homebuilders, possibly to overcompensate for their looseness on mortgage ratings leading up to 2008, even though no major homebuilder has defaulted in over a decade. Another issue is rampant, demonstrated groupthink. Rating firms almost all tend to cluster together and rarely diverge from industry consensus–and tend to rush to downgrade at the same time.
In Fitch’s defense, perhaps their downgrade has reaffirmed the dangers surrounding the persistent political brinksmanship over lifting the “debt ceiling” every couple of years. Even the first author’s high-school-aged daughter smartly wonders why this centuries-old anachronism is not simply abolished when it serves no practical purpose other than to threaten the nation’s creditworthiness. Good question–and tougher to answer at home than why the U.S. has only two major political parties or why the sky is blue! No other nation on the planet has such needless self-imposed fiscal tripwires to tempt partisan malice–other than Denmark, which somehow manages to share the Danish without having a food fight.
Fitch’s self-serving downgrade of U.S. debt serves no purpose–and has been rightly condemned across the political spectrum and across the business world.
Jeffrey Sonnenfeld is the Lester Crown Professor in Management Practice and Senior Associate Dean at Yale School of Management. He was named “Management Professor of the Year” by Poets & Quants magazine.
Steven Tian is the director of research at the Yale Chief Executive Leadership Institute and a former quantitative investment analyst with the Rockefeller Family Office.
The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.
