U.S. AAA rating is meaningless

Today the U.S. House of Representatives passed yet another hike to the debt limit of the United States. As it passes to the Senate Bloomberg makes an important note:

Democrats abandoned plans for a bigger debt-ceiling boost following conflicting demands among their rank and file over proposals to reduce the government’s budget deficit. The bill passed yesterday means Congress will have to vote again early next year to raise the debt ceiling.

Without the new increase, the Treasury Department would hit the current limit by Dec. 31, lawmakers said, which would force the government to default on its debts.

With it passing the house by a scant four votes due to dozens of Blue Dogs voting against the increase its chances in the Senate are highly questionable. The fact it has been so close makes the potential for another increase being passed in February much lower. Debt actually went above the limit in real terms though the Treasury quickly assuaged fears by noting that it has a number of "accounting tools" that allow it $150 billion of additional slack. Amazingly rating agencies insist the U.S. has no serious risk of losing its AAA credit rating until 2013.

However, should the U.S. Congress fail to pass an increase in the debt limit this month or in February default will be inevitable. Once the debt limit is reached no debt can be raised to pay off liabilities or debts. Credit rating agencies always take into consideration the political situation in a country including whether there is sufficient political backing to reduce credit risk. A failure to raise the debt limit would entail an imminent credit risk and the narrow passage of this increase means such a failure has a high probability of occurring if not now then sometime soon. No budget proposal being contemplated would erase the deficits or reduce them by sufficient measure to offset the rapid growth in borrowing. With strong resistance to large increases to the debt limit this constant battle is likely to continue. Such political squabbling over this significant issue would justify at the least a one-notch downgrade for the U.S.

The UK had its outlook downgraded and the possibility of a downgrade was raised if the 2010 general elections do not lead to a majority victory for any party. Yet the near failure of the Democrats to pass the debt limit hike in spite of overwhelming majorities because of defections in their own party is not an apparent issue. Given this consistent failure to act it begs the question of why there seems to be such little action taken by the credit rating agencies? All three major credit rating agencies, Fitch, Moody's, and Standard & Poor's, are based in New York City and regulated by Securities and Exchange Commission. Since ratings agencies are paid by the issuer this means the three most influential credit rating agencies are paid to provide credit ratings by the same government that regulates them.

Given the great deal of controversy over the failure of credit rating agencies to give appropriate ratings to mortgage-backed securities how much assurance is there that a corrupt bargain does not exist? As the government could easily close down these credit rating agencies what incentive do they have to bite the hand that feeds them?