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Credit Ratings Agencies Playing God

Posted on: May 9th, 2010

THEY all bear neutral names, like ‘Moody’s,’ ‘Standard & Poor’s’ and ‘Fitch’. Such soothing sounds disguise fiendish power. So far this year the dreaded global ratings agencies seem to have flown below the Irish radar. Probably because they have been nursing self-inflicted wounds.

Last year they managed to perform a feat almost unparalleled in Irish politics. They united Fianna Fail’s Brian Lenihan and Labour’s Joan Burton against them.

In March 2009 Frank Gill of Standard & Poor’s went way beyond his brief of dishing out a bad credit rating to Ireland. On Newstalk he called for “new faces” in Irish government. Labour’s Joan Burton, a seasoned critic of both US credit agencies and the Irish government, was vociferous in telling Frank to back off. According to Joan, we did not need the likes of Frank telling us who to put in power. That was her job.

After that, Frank backpedalled furiously. We have not heard much from the agencies on the national airwaves since.

But last week RTE’s Sean Whelan began to highlight their role on Morning Ireland.

Speaking to presenter Aine Lawlor from Lisbon, Sean said that several European leaders were fed up with the transatlantic trio. Instead, they were seeking a European ratings agency.

Ten days ago the arbiters of credit had relegated Spain. Then on Tuesday, as Moody’s threatened to downgrade Portugal, European commissioners were suddenly lining up to rubbish the agencies. Even European Commission chief Jose Manuel Barroso waded in to give them the thumbs down. Barroso, probably irked by the previous day’s humiliation of his native Portugal, lashed out at the US agencies’ irrational concerns with immediate market mood, accusing them of ignoring economic fundamentals. He bemoaned the lack of European competitors to the US troika.

German chancellor Angela Merkel was said to be incensed with US agencies wrecking and dictating Europe’s credit ratings. According to Merkel, the three foreign outfits did not understand the subtleties of Europe and were interested merely in short-term prospects.

Merkel and Barroso have a point. Ratings agencies play God. They make judgments on the credit ratings of nations, their banks and their bonds. Once a verdict is given the victims head into a downward spiral — or, if they are re-rated upwards, they spike unexpectedly. These self-appointed bodies are fearfully influential. Even the markets bow in the face of the agencies that play God.

Fortunately, God is infallible. Not Moody’s, Standard & Poor’s and Fitch. God does not suffer from conflicts of interests. Unfortunately the all-powerful deities of the financial markets have been exposed as false Gods with awkward internal conflicts.

Mrs Merkel need not have worried about their misreading of Europe’s economies. They got it hopelessly wrong at home as well.

One of the fiercest critics of ratings agencies is celebrated US economist Josef Stiglitz. The heretical guru did not mince his words of condemnation: “I view the rating agencies as one of the key culprits … They were the party that performed the alchemy that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the rating agencies.”

Stiglitz is right. It is impossible to understand how banks in the US were gaining top ratings when they were selling dud bonds to punters or even to big institutions. Stiglitz was not alone. Back in autumn 2007, the US Senate banking committee savaged their own agencies — but sadly two weeks after the Lehman’s horse had bolted.

The committee found that the worst example of the agencies’ failure was during the subprime crisis earlier that year. As disaster approached, all three agencies were giving top ratings to promoters of subprime mortgages.

Investors trusted the agencies’ judgment and piled in — but they lost their shirts when these investments proved worthless. Democratic Senator Carl Levin, who headed up the Senate panel, summed up matters: “A conveyor belt of high-risk securities, backed by toxic mortgages, got AAA ratings that turned out not to be worth the paper that they were printed on.”

This fatally flawed judgment, in the case of subprime mortgages, was compounded by Standard & Poor’s added failure to predict the bankruptcy of all the Icelandic banks or the precarious financial position of the Icelandic government itself before the volcanic nation and its tumbling banks fell off a cliff.

Iceland had been a go-go country until it suddenly collapsed. The early warning systems of the ratings agencies failed to function.

The US banking committee further recalled the failure of the agencies to spot the Enron disaster or to blow the whistle on Worldcom.

The arrogance in telling the Irish Government to change its Cabinet members was bad; the sin of calling Enron wrong was worse; but the AAA ratings given to subprime mortgagors was the green light for the global banking crisis. That mistake should have been fatal for the agencies. Far from it. They live on today, dishing out credit downgrades to nation and banker alike.

How do they get away with it, despite the loss of credibility? Their credibility may be damaged, but their sponsors continue to support them. Because, in the words of Stiglitz, the banks could not have done their dirty work without the agencies’ “complicity”. The mutual interdependence continues.

Joan Burton, Ireland’s most articulate critic of these agencies, explains it by insisting that the ratings agencies are “on both sides of the fence”; that they are making judgments about some of the bonds from issuers who fund their operations.

The Labour Party finance spokesperson is again on the button. But Joan is not on her own in finding a fundamental problem with Moodys, Standard & Poor’s or Fitch.

The US Senate banking group was equally outraged. Fresh criticism has been fired in their direction in recent weeks. According to the New York Times, the agencies were savaged back on their home turf. US senators, having earlier rumbled their failure to give early warnings on Enron, Iceland and subprime, have now highlighted a possible reason. They have accused the agencies of conflicts of interest, confirming that they are frequently paid by the companies whose bonds they rate. Senator Robert Menendez accused them of being both “coach and referee in giving advice to issuers of debt”.

And two weeks ago Senator Carl Levin went even further. He was unequivocal about how conflicted they were: “Credit rating agencies allowed Wall Street to impact their analysis, their independence and their reputation for reliability.

“They did it for the big fees that they got.”

A stab in the back from the home team is far more lethal than European leaders bleating. Perhaps no one, except the insiders, fully realised that the judges were funded by the defendants.

But now that we do, we should dispense with their services. So the Merkel/Barroso idea of a European ratings agency, not paid for by vested US banking interests, is an imperative.

An objective verdict on the credit-worthiness of governments, banks and bonds is an invaluable tool in the rapidly changing world of debt. The current crop of quaintly named Fitch, Standard & Poor’s and Moody’s have failed to fill that role.