Lately, there has not been a week without a warning or a cut in the credit rating of European countries, worsening their financial situation and bringing the reform of credit rating agencies back under the spotlight.
After having been accused of being largely accountable for the global financial crisis (GFC), Moody’s, Standard and Poor’s and Fitch (the ‘big three’) have simply and unapologetically returned to their daily grind with seemingly intact legitimacy, their usual aura of infallibility and -above all- influence remaining in. It is as if they had never contributed to what has been the most important financial turmoil since the Great Depression!
In his column in the New-York Times Paul Krugman stresses that the examination of e-mails exchanged by employees of credit rating agencies reveals a ‘deeply corrupt system’, in which issuers of debt hired the credit rating agency which gave the best rating to their debt. The ‘big three’ consequently distorted their notations to satisfy their clients, and 93% of the subprime-mortgage-backed securities that were rated AAA in 2006 were in fact ‘toxic assets’.
It did not take more for some scholars and politicians to argue that the ‘big three’ work in favour of Wall-Street and, more generally, in favour of the United States. On Tuesday 15th June the members of US Congress did not ratify the Franken amendment, which resulted into a terrible status-quo as the purpose of the amendment was to implement conflict interest rules for the rating agencies industry. This non-ratification clearly shows the huge influence of financial industry lobbyists on Congress.
While arguing that the ‘big three’ work in favour of Wall-Street may be considered extreme, it is true that they are maintaining a climate of uncertainty over financial markets at a time when the latter are afraid of their own shadows.
In the early stage of the European debt crisis, Standard and Poors’s downgraded Greece’s rating and put the already weakened country into a highly critical situation. At the end of May, Fitch in turn cut Spain’s rating. On 15th June, Moody’s downgraded the sovereign debt of Greece to junk status just as Greece had concluded a macroeconomic policy agreement with the European Commission, the European Central Bank and the IMF.
The timings were rather well-chosen - or badly-chosen, depending on which side of the Atlantic you stood. Good times for speculators of the US financial sector indeed mean bad times for Greece, Spain and Europe in general.
Lately there has been a will both in the US and Europe to break the oligopoly of the ‘big three’ and to increase the transparency of their functioning.
In early June the US Security and Exchange Commission introduced the rule 17g-5, which requires that the information used for rating be available to all rating firms.
The European Commission took a similar decision in order to increase competition and plans on creating a new pan European Union regulatory body that would supervise the operations of agencies.
However, it is still unclear who should funds rating agencies or how ratings should be assigned. The key issue remains unchanged i.e. issuers of debt will continue to pay for ratings, and it is unlikely that investors will be the ones to pay.
Reforming credit rating agencies is crucial, and urgent. In the short- to medium-term, the absence of any restructure could threaten the economic recovery of Europe and could compel countries to leave the Euro-zone. In the long-term, it could possibly generate another GFC.
Arnaud Eard
Arnaud comes from Paris and gained a MA in International Political Economy at the University of Sheffield. He has been interning at Bluegrass Consulting since May 2010.
