Credit ratings need to be market-based

It has been a tough few years for credit ratings agencies.  We had the financial crisis with toxic subprime bonds going down at absurdly high ratings.

Most recently S&P downgraded the US Government to AA+ from AAA, which fundamentally makes no sense.  Apparently Warren Buffet agrees.  Now, S&P may be right to be worried about the long-term sustainability of US debt levels.  What I don't understand is how Microsoft bonds can still be AAA.

Let's go through a little thought experiment.  Let's say the US Government starts to get into trouble and bond investors everywhere start demanding higher interest rates.  Most would consider an actual default incredibly unlikely.  It is much more likely that the Fed would ease to drive interest rates back down.  That's right, the government would print their way out of the problem.

But Microsoft issues their bonds in dollars, same as the US.  And oh by the way, they have 51,000,000,000 of those same US dollars on hand - probably sitting mostly in Treasuries.  So a devaluation of the dollar certainly would have a big impact on Microsoft.  So again, if the US government isn't AAA, it is hard to see how Microsoft should be AAA.

Over at IndexUniverse, Matt Hougan wisely points out in his bond indexes post, which I have referenced before, that we should prefer a market-based approach to the question of bond quality.  You can be assured of one thing - Inveska will never take credit ratings seriously.