My first full-time job after graduate school was with the New York State Bureau of Weights & Measures. I was tasked with the unenviable job of convincing New Yorkers to convert from the customary units of measurement (length, mass, and volume) to the metric system.
For those who are unacquainted with the metric system, it is based on 10s or a decimal-based system of measurement. It is the international system established to standardize weights and measures, making it easier for consumers to compare prices for a given amount of goods.
While much of America today has clung on to feet, gallons and pounds (notwithstanding my efforts), the metric system is used in a variety of industries including medicine, science, military, as well as the fixed-income market. As an aside, Thomas Jefferson, one of the nation's founding fathers, was a key driver of the 1792 establishment of the decimal-based currency system we use today. He also endorsed the adoption of the metric system (which failed to gain approval).
We in the bond industry are quite familiar with a decimal-based system in the course of conducting business - - Interest rates and basis points (one basis point is equal to 1/100th of 1%, 0.01%, or 0.0001) are key components in determining the price of bonds when buying and selling securities.
On the other hand, municipal credit ratings have held on to the long-standing alpha-numeric system to measure relative credit quality among bonds. Fitch, Moody's, S&P and Kroll all use an alpha-numeric framework - - some use all capital letters or a combination of large and lower case letters for major rating categories and numbers or +/- as qualifiers applied to the category to distinguish the upper and lower range of that rating category.
Household investors hold about 42% of all bonds outstanding. To the casual investor, credit quality comparisons between rating agencies may well be confusing and difficult to decipher.
Despite the diversity of credit rating schemes, all the agencies do share a common, but overlooked, element of conformity. Investment grade ratings could easily be converted to a 1-through-10 decimal-based system with bonds rated AAA/Aaa (or '10') having the highest credit quality and BBB-/Baa3 (or '1') assigned to the lowest credit quality category. The same scheme could be applied to non-investment grade ratings as well.
Conservative investors typically tend to buy bonds along the higher end of the credit spectrum of investment grade bonds (AAA rated bonds would be equivalent to a '10'). A more sophisticated or aggressive investor, however, may be willing to purchase bonds at the lower end of the investment grade credit scale (BBB- bonds would be equivalent to a '1') to receive a higher yield, although exposed to a greater amount of credit risk.
There are four compelling reasons for the adoption of a decimal-based rating system:
1) Conversion of the alpha-numeric ratings to a 1-10 scale can easily be done.
2) It would facilitate rating comparisons across rating agencies and credit quality.
3) It would simplify investor purchase decisions based on credit quality
4) It would reduce ambiguity, provide clarity, and promote market transparency.
I am not suggesting the wholesale elimination of letter grades in exchange for a decimal rating scale at this time. However, as an industry we should consider moving towards such a rating scheme. I think that Thomas Jefferson would approve of the rating modification, which would have the advantages of convenience, simplicity, and familiarity.
