Who will finally sit Gordon Brown down with a bottle of whisky, a loaded revolver and a copy of his own book on courage, and tell him the game is up? You might imagine the task would fall to Jack Straw, flanked by a couple of union bosses. In fact, it’s more likely to be three men you’ve never heard of: Frank Gill, Arnaud Mares and Brian Coulton.
Working respectively for the ratings agencies Standard & Poor’s, Moody’s and Fitch, this trio have the job of deciding whether the UK can pay back the hundreds of millions of pounds Brown’s government is borrowing every day through the gilts market in order to keep afloat. One day soon, it may be their job to declare that it can’t. ‘Britain should lose its triple-A rating,’ said Stuart Thomson, a bond fund manager at Ignis Asset Management, which has £70 billion under its control. ‘If the ratings agencies were being honest, they would downgrade the UK.’
Indeed they would. The government is racking up debt at an alarming rate, has no plan for paying it off, and shows no inclination to develop one. There is little sign of willingness to shelve any major spending proposals. The three agencies have punished other economies for far lesser sins. But cutting the UK’s rating would have huge repercussions — for Brown, for the British taxpayer, and for the agencies themselves. It would send sterling reeling and plunge us back to the dark days of the 1976 IMF rescue. For a Prime Minister who spent ten years as Chancellor boasting about ‘prudence’ and ‘golden rules’, it would be hard to imagine a worse blow.
The global capital market doesn’t actually have a stern-looking bank manager who ticks you off for extravagance, stops your overdraft and programmes the cash machine to eat your card. What it does have are rating agencies, whose job is to grade every borrower in the bond markets — companies and countries — for credit-worthiness. The most sought-after rating, ‘Triple-A’, is reserved for the soundest borrowers: below that, the ratings go all the way down to C, at which point your paper is officially ‘junk’.
Ratings matter, for two reasons. They impact on how much you pay to borrow. Every notch you drop down the scale, the price of borrowing rises to reflect the perceived increase in risk that investors are taking on. Perhaps more importantly, ratings also determine who can own your debt. Gilts are often owned by pension funds or foreign central banks, which classify them as part of their reserves. Both are often only allowed to buy Triple-A paper. Lose that status, and your best customers can suddenly no longer touch your bonds.
For Britain, that is crucial. According to the Debt Management Office, the UK will have to sell £240 billion of debt in 2009-10 — an alarming £657 million a day. At the end of 2008, of the £616 billion of government debt outstanding, £245 billion was held by insurance companies and pension funds, and £260 billion was held overseas. Theses figures make one fact abundantly clear. To have any chance of shifting £240 billion of debt next year, the UK needs to stay Triple-A, as it has always been.
But in markets, nothing is permanent. Japan was downgraded by Fitch in September 1998: at the time, the Japanese government was struggling with a huge volume of problem loans in its banking system, and a third consecutive quarter of negative growth (sounds familiar, eh?). Moody’s and S&P followed suit.
Last month, Fitch and S&P cut their ratings for Ireland from Triple-A, in response to the bailout of Dublin’s banks and a terrifying 8 per cent contraction in Irish GDP. After the downgrade, all hell broke loose: comments by S&P’s Frank Gill on Irish radio were interpreted as meaning the government needed ‘new faces’ to restore credibility to the nation’s finances. S&P managing director David Bears promptly wrote to Irish finance minister Brian Lenihan to apologise. ‘Frank Gill and I regret any misunderstanding arising from his comments in the interview,’ he grovelled. ‘We take a strictly neutral stance on the policies of the 125 sovereign governments for which we have credit ratings.’
But that was a mere skirmish compared to what will happen if they cut Gordon Brown’s rating. ‘They can downgrade Italy or Ireland,’ says Thomson. ‘But London is a major financial centre, and they can’t afford to damage their relationships with officials.’
It’s true that all three agencies are woven into the City’s fabric, and depend on it for their income. Nor do the problems stop there. ‘The political problem is really in the US,’ said Marc Ostwald, a strategist at Monument Securities. ‘Any move to cut the UK rating, or even to put it under review, immediately begs the question of why they aren’t doing the same thing for the US. It is following very similar policies to the UK.’ Indeed so. But cut the rating on US Treasury bills, and the world financial system would be right back hanging over the brink of the abyss.
On the other hand, the UK really isn’t looking very creditworthy. When Fitch downgraded Ireland, the agency pointed out that that Irish debt was set to climb above 80 per cent of GDP, and argued that the ‘collapse in government revenue has also revealed structural weakness in the underlying budgetary position, previously disguised by property and asset market-related buoyancy’. It is hard to see why the same logic doesn’t apply to the UK. Tax revenues from the City and property markets have collapsed and our total debt will soon be over 100 per cent of GDP. Irish annual borrowing will peak at 10 per cent of GDP, compared with 12 per cent for the UK, and that is just the official forecast. Analysts have pencilled in 15 per cent, and even that might be exceeded. ‘Given the likelihood that borrowing turns out to be far higher than the current projections, because the growth forecasts are too optimistic, then the rating is probably going to have to come under review at some stage,’ said Ostwald.
In truth, the only reason right now for downgrading Ireland and not the UK is that it’s a small country that doesn’t matter much. Officially, the three ratings agencies are doing nothing more than baring their teeth. ‘The UK economy and public finances were not well positioned at the onset of the crisis,’ snaps Moody’s in its latest assessment. The government will have to ‘reinforce the commitment to stabilising and reducing public debt ratios over the medium term once there is clear evidence that economic recovery is underway,’ warned Fitch after the Budget.
But the agencies are caught between a rock and a hard place; or rather between a big clunking fist and a tight corner. They don’t want to earn the enmity of the British government. On the other hand, they’re paid to deliver honest assessments of creditworthiness. They’ve already been hammered for awarding Triple-A ratings to bundles of subprime mortgages. They need to start restoring their credibility — and they can only do that with brutally honest assessments of borrowers.
People in the bond markets reckon Fitch will break ranks first, as it did with Japan. It is subject to the least political interference. Most people in Westminster won’t have heard of its chief economist, Brian Coulton. But if Britain is declared bankrupt, Brian is the man most likely to bring down the hammer.
Comments