Not because of the UK downgrade, ridiculous though that is. Downgrading a sovereign currency issuer is simply silly. The Bank of England is the "buyer of last resort", so there is zero risk of the UK defaulting on its debt. And as FT Alphaville pointed out, downgrading a country because of the possibility of inflation breaks Moody's own definition of "default". Yes, bond-holders may be paid back in currency that is not worth what it was when they bought the bonds. But that doesn't mean they haven't been paid. "Soft" default, in Moody's definition, is not default. And anyway, inflation wasn't the risk that Moody's identified. The reasons given for the downgrade were poor growth and delayed fiscal consolidation:
"The key interrelated drivers of today's action are:
1. The continuing weakness in the UK's medium-term growth outlook, with a period of sluggish growth which Moody's now expects will extend into the second half of the decade;
2. The challenges that subdued medium-term growth prospects pose to the government's fiscal consolidation programme, which will now extend well into the next parliament;
3. And, as a consequence of the UK's high and rising debt burden, a deterioration in the shock-absorption capacity of the government's balance sheet, which is unlikely to reverse before 2016."
For a currency-issuing sovereign, none of those in any way increase the likelihood of default. Therefore the UK's downgrade on Friday 22nd February was meaningless. Markets reacted immediately - sterling fell, of course. But by Monday morning they'd had time to think about it, and the gilts market stayed solid:
And later that day sterling not only regained what it had lost but rose a bit against both the Euro and the US dollar because of Eurozone worries arising from the Italian election stalemate. So much for those who argued that the downgrade meant the end of sterling's "safe haven" status. Markets thought otherwise:
(larger version here)
But that's not the madness of Moody's. The madness is contained in this gem of a release. Moody's has seen fit to downgrade the Bank of England, two universities, English housing associations, Transport for London and five local authorities.
Well, it would be reasonable to downgrade the central bank if you downgrade the sovereign. And downgrading the universities that issue bonds is also reasonable, except for Cambridge (downgrading Cambridge would have been certifiable insanity). As is downgrading English housing associations and Transport for London, which also issue their own bonds. That's not the real lunacy. No, it's the downgrade of local authorities.
It seems that some local authorities in the UK have obtained credit ratings with a view to issuing bonds at some point to fund infrastructure projects. And the Greater London Authority actually issued bonds to pay for Crossrail. It seems reasonable therefore that Moody's might downgrade them. But Moody's have forgotten that unlike US states, UK local authorities do not have independent tax-raising powers. Business rates are set nationally, and household rates are capped by central government. Therefore any bonds that UK local authorities issue are de facto backstopped by the sovereign. Even the individual countries within the UK do not yet have tax-raising powers and therefore cannot issue debt that is independent of the sovereign: the Treasury has agreed in principle that if Scotland remained within the Union (which won't be known until 2014) the Scottish government could be enabled to issue its own debt when it takes on tax-raising powers as part of further devolution. At present, therefore, any municipal bonds issued by UK local authorities are effectively sovereign debt.
Now let's remember what the purpose of agency credit ratings is. It is to inform investors of the default risk of potential investments. Credit ratings agencies are of course deeply wounded after the CDO ratings failures in the financial crisis, so they are trying to redeem themselves by producing "sensible" ratings - which essentially means they don't tell us anything we don't already know. The UK's downgrade was widely expected and already priced in, and Moody's statement added nothing new to the debate. But downgrading local authorities that can't independently issue debt is simply idiotic. Investors cannot invest in the debt of local authorities whose debt is effectively guaranteed by the sovereign. All they can invest in is UK sovereign debt - even if it is called "local authority bonds".
Since UK local authorities cannot issue debt independently of the sovereign, BY DEFINITION they must all have the same credit rating as the sovereign. Separately downgrading them is nonsensical. This action does nothing whatsoever to restore confidence in Moody's. On the contrary, it makes one wonder whether they have the faintest idea what they are doing. Is anyone really going to take them seriously any more?
Moody's downgrades UK's government bond rating to Aa1 from Aaa - Moody's news release
This downgrade is nonsense! - FT Alphaville
Talking about a sterling revolution - Financial Times
Moody's takes action on UK sub-sovereigns - Moody's news release
Local councils turn to the bond markets to finance infrastructure projects - Telegraph
Consultation opens over Scottish bond issuing power - BBC
Charts from Bloomberg and Yahoo! Finance.