The UK faces the prospect of losing its much-vaunted AAA credit rating, Moody’s has said. But who is Moody’s and does its opinion matter?
WHO ARE THEY?
Moody’s – founded by John Moody in 1909 – is a company whose purpose is to assess the credit worthiness of countries and companies. Essentially, seeing how likely you are to get your money back if you lend them some.
John Moody invented his rating system – ranging from AAA for the safest investments to C for investments with “little prospect” of getting either your money back or any interest – to give people an at-a-glance way of assessing securities.
ARE THERE OTHER RATINGS AGENCIES?
Yes. Moody’s is one of three main ratings agencies. The others are Fitch and Standard & Poor’s.
However, as they all look at the same data, a downgrade by one is generally followed by a downgrade by the other two.
WHY DO THEY MATTER?
They matter because a lot of investors listen to them. The UK government borrows billions and billions of pounds a year to cover the gap between its spending and its income from taxes. We spent £14billion more than we gathered in December alone.
On top of the new borrowing, we have a massive amount of existing debt - £1trillion according to the latest reckoning – that we’ll need to “roll over” (re-borrow) unless we can pay it off first. Something that’s not overly likely in the next few decades.
So the price we get charged to borrow this money is vital to the UK’s plans. And the opinions of the market matter.
In April 2010 it cost Italy less to borrow money than the UK. Today it costs the UK less than 2.5% while it costs Italy almost three times that amount.
A rise in our borrowing costs of just 1% would "force taxpayers to find an extra £21billion in debt interest payments” George Osborne said in his Autumn Budget Statement. That’s almost as much as the entire transport budget.
That said ratings aren’t the be all and end all. When the US was dropped a notch by credit ratings agencies last year, it barely impacted the country’s borrowing costs.
HOW DO THEY DECIDE THEIR RATINGS?
When rating a country, Moody’s looks at things like the money coming in from taxes, how much debt the country is in, prospects for growth and how likely the government is to make its sums add up.
One of the reasons the UK has escaped credit rating downgrades despite its massive debt is the belief that if we’re in trouble the Treasury could raise taxes and the public would pay up.
Tax evasion is a far bigger problem in countries like Greece and Italy, leading to their ratings downgrades and increased costs of borrowing.
CAN THEY BE TRUSTED?
Broadly they can – but there have been big mistakes. Enron was rated AAA a mere week before it went bust and during the boom years mortgage-backed assets were rated AAA – the safest rating available.
But by 2008 these became almost universally known as “toxic assets” and were largely responsible for the credit crunch and the ensuing recession as a lack of trust saw the financial system collapse. They lost even more credibility with the public when it emerged it was the big banks themselves who were paying for their securities to be rated in the first place.
That said, they have generally been reliable so far when it comes to rating countries and how stable they are. This is because there is more information freely available about the state of a country’s finances.
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