S&P Lowers Outlook on Russia!

By The Greek - Economy and Markets:

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(This piece contains a degree of sarcasm that should be clearly apparent, and is meant for entertainment. At the same time, the article touches on some important topics of interest and concern).

I think many of us shuddered yesterday when we read about S&P's sovereign rating warning issued to Russia. I mean what were they thinking! This is Russia we're talking about. The same country that turns off the gas to the Ukraine, Belarus and Georgia every winter, reminding their ex-Soviet pals and all of Western Europe (especially Germany) of their dependence on Russian energy. This is the same Russia that brutally invaded and pillaged its little neighbor in August after provoking it into conflict. In other words, Russia don't play...

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Red October might play out in reality, as Russian U-Boats possibly work their way up the New York Bay and into the East River, possibly taking aim on 55 Water Street, the headquarters of Standard & Poor's (NYSE: MHP). I don't think S&P was thinking clearly when it issued a ratings warning on Russia yesterday. I mean, that building sits right smack on the East River, and is wide open for Destroyer Neustrashimy attack. Seriously though...

Standard & Poor's Ratings Action

S&P affirmed Russia's long-term foreign currency rating of BBB+, along with long-term local currency ratings of A- and short-term rating of A-2. However, the action that caught Russia's ire was S&P's reduction of Russia's sovereign credit outlook to negative from stable, reflecting an increased probability of future downgrade.

Two things you don't do in relation to Russia:

1. You don't threaten to downgrade Russia
2. You don't downgrade Russia
   

Russia has been undeniably hurt by the halving of crude oil prices in a matter of months. At the same time, the global economic crisis and its own poor decision making regarding Georgia have compounded upon ruble rubble. Over the last few years, Russian coffers have filled, thanks to increasing oil production and rising crude prices. Things have changed though, and the current environment has hurt Russia's ability to handle crisis-level capital needs.

Some of its pain has been Russia's own doing though. Since about when the Olympics began and Russia tricked Georgia into war, investors have given second thought to the red country's risk. That re-evaluation has helped pull at least $63 billion of investment capital out of Russia since August 8th, according to UniCredit SpA. Russia has nobody to blame but itself for that. The world witnessed the modern day pillaging of Georgia, not to mention the brutality of the invasion itself, including the murder of civilians, and even press, which is of course a greater sin. Cold comments emanating from the Kremlin, as Europe and the United States sought to prevent full-scale massacre, served as a real wake up call to investors who had previously viewed Russia as progressive.

The global economic crisis is another story. Russia has committed as much as 15% of GDP in budgetary and reserve funds toward preserving its financial system. To be specific, the nation has committed $200 billion toward stemming the crisis, with $86 billion recently allocated to help banking liquidity. Last week, Russia's reserves stood at 515.7 billion, after shedding $15 billion in the past week to stabilize the ruble.

Russia's Reaction

Signs that Russia had not taken the credit warning well began surfacing almost immediately. Russia seems to suspect U.S. government influence in the action, if we've read into recent statements accurately. Medvedev mildly stated, "We are perhaps better prepared for the situation than many other countries." (read U.S.A.) Paraphrasing, a Russian fixed income analyst noted that Russia had a budget surplus and the third largest foreign reserves in the world; he went on that Russia could rescue banks on more than just the brand value of its name. He was clearly implying that Russia was in better shape than the U.S., which may in fact be true! Nyet...

Today, however, more clear evidence of economic tension and possibly even warfare surfaced. The U.S. State Department imposed new sanctions on Russian and Chinese firms doing business with Iran, North Korea and Syria in the fields of missile systems and businesses capable of supporting WMD programs. This didn't go over well in Moscow, where legal premise is perhaps valued more highly than moral inspiration. Russian Defense Minister Sergei Lavrov said, "These new sanctions were introduced without any international legal foundation whatsoever.... Russia will of course take this into account..." Interestingly, he went on, "There can be no other explanation here than the rather arrogant extraterritorial implementation of American laws."

Trouble is Brewing

It's clear that trouble is brewing to a boil with Russia, and that leaves us with great concern regarding how Russia might react to an eventual U.S./Israeli confrontation of Iran. More importantly, we wonder what more Russia might do to help prepare Iran for that eventual conflict.

S&P's rating decision may have solid footing, and we're not arguing that. However, the issue of sovereign debt rating is an important one that perhaps deserves some inspection while Congress is looking at the agencies. Still, it seems clear that this is one segment of ratings that cannot be taken under government control, due to obvious conflicts of interest with global trading partners.

In its action this week, S&P may be unwittingly getting involved in a stealth economic war. Ratings are important to the economic interests, and thus state interests, of nations. We're sure this is something Russia and other countries view important enough to do their best to influence, and nations influence things in many ways. Russia's intelligence program is estimated now reinforced back to its old cold war KGB level. This is yet one more reason why regulation on credit rating agencies should be strengthened. In last week's Congressional testimonies, an ex-S&P employee, Frank Raiter, while referring to the topic of the testimonies, said the level of surveillance needed improvement. His own words were actually stronger, and can be seen here: Congressional Testimonies on Credit Rating Agencies and bits within our weekly videos.

Imagine a scenario where an analyst or group of analysts are influenced by foreign intelligence. We don't think this is such a far-fetched scenario considering the degree of importance sovereign ratings have to national economic interests. One thing's for certain, that job better pay well, because it entails extraordinary risk. For that matter, both internal and governmental controls of high intensity would be well advised... Judging by recent Congressional testimony and findings, it seems highly possible that these do not currently exist. We would hope Congress would take a look now that the books are open, and insure no future mishaps occur.

In any event, if we're taking bets on who might win in battle, the credit rating agencies or Russia, then my money is on the agencies. Any group that could seemingly play such a great role in bringing down the global economy via alleged flawed ratings, also seems entirely capable of taking out Russia.


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