The backlash to Credit Ratings Agencies gathers steam


by Ben Mitchell    
1:10 pm - March 13th 2012

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“The three credit ratings agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly…”

The damning verdict by America’s Financial Crisis Inquiry Commission in January 2011 laid significant blame with the main credit agencies for the credit crunch and subsequent crash of 2008.

And yet, and yet, the chancellor still woos them, still panders to them, warning the country that last month’s ‘negative’ outlook for Britain’s triple A rating was merely ‘a reality check’ that must be heeded.

But, very soon, the chancellor may well find himself as the only person believing the agencies’ hype.

The effects of Standard & Poor’s (S&P) US downgrade last year had a negligible effect on the market’s confidence in the US, and in fact led to them buying up Treasury bonds and pushing down long term interest rates.

That echoed similar such behaviour in the past after other so-called ‘safe’ investment countries (Japan and Canada) had seen their credit ratings fall.

As one leading economics commentator points out, Japan has had its credit rating downgraded several times over the last couple of decades. The result? “Japan is now paying the lowest long-term interest rates in recorded economic history.”

When France lost its S&P triple A rating, President Sarkozy reacted with disdain, treating it as a non-event and saying it “changes nothing.” The European Central Bank’s president, Mario Draghi, has questioned the importance of the credit agencies, believing them to be a distraction. “We should learn to do without [them],” he’s said.

All of which are finally coming under increased scrutiny.

In written evidence submitted to the Committee, The Co-operative Party, which is campaigning for reforms to financial services, drew attention to the agencies’ conflict of interest:

…the largest source of income for the rating agencies are the fees paid by the very companies that the rating agencies are supposed to impartially rate.

They went on to point out that:

Despite the fact that inaccurate credit ratings were a primary cause of the crisis, agencies remain largely unaccountable to either investors or regulators. Part of the reason for this is their assertion that they merely provide opinions and as such are protected by free speech provisions.

Yet major market participants are continuously encouraged and sometimes even obligated to utilise rating agencies.

The backlash has begun.

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About the author
Ben Mitchell is an occasional contributor. He is a freelance political analyst providing commentary on current affairs. Blogs more frequently at Left Foot Forward and Ben Mitchell Writes.
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Reader comments


You’re conflating sovereign ratings and ratings for specific financial products. Very different things.

When it comes to sovereign ratings, all the agencies do is comment on publicly available information. When France was downgraded, its sovereign debt was already trading at a substantial premium to, eg, Germany’s. It’s rarely rocket science.

The real drawbacks of the ratings agencies were exposed in their ratings of financial derivative products, where they over-relied on computer models/equations, and were pretty easily gamed by the likes of Goldmans. By way of example, I used to draft CDO-based products at a law firm. The bank would spend a few weeks drawing up the financial structure of the CDO. We’d then spend a week or so drafting it up. We’d send it to a rating agency to rate it (we’d obviously have provided the draft rating ourselves), and they’d turn it round overnight. No chance of proper analysis of the product there – they were just putting it through a model.

So what alternative do you propose? Should credit be rated or not? How should my pension fund be invested if we have no credit rating? How should we decide what interest rates to charge for loans? Whatever we do, creditworthiness will still be assessed in some form or other, and if private companies don’t do it, then states will. Imagine Greece/Italy/etc determining their own credit rating.

Yes, but don’t you understand, they are just providing an impartial service for investors, people arent forced to listen to them, its the hidden hand of the market at work, just set it free…Sorry I found myself in the crazy topsy turvy world of the naive and childlike yet sociopathic right-wing imagination for a minute there.

@2 – The point is to reform the system so that we don’t have 3 companies monopolising ratings, and therefore having undue influence. The European Association of Credit Rating Agencies (EACRA) are trying to rectify this.

See their evidence at the Treasury Select Committee:
http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/writev/1866/cra15.htm

4 – not convinced by this part of the summary:

EACRA views the monopolisation of the credit rating industry by three agencies as the driving cause of problems now being faced in the market for sovereign bonds, and previously in the market for structured securities (the “sub-prime” crisis). A change in position by one of only three opinion-makers inevitably has a massive effect. Increase the number of opinions and the impact of one is reduced. In any case, negative ratings do not have a lasting effect on a sovereign or a corporate if there is no financial or economic weakness – bad news is conveyed, not caused, by its bearer.

If negative ratings are just conveying, rather than causing bad news (which, in terms of sovereign ratings, is absolutely right) how on earth can the rating agencies be any sort of cause (let alone “the driving cause”) of the problems faced in the European sovereign debt market? The one concept precludes the other.

Can anyone explain how this oligopoly (you can’t have three companies monopolising anything) came about? My guess is that this relates to regulatory requirements and the need to have established and recognised assessments to meet government requirements.

After all, what is to stop anyone issuing their own ratings – this is not a proper oligopoly in that they are not limiting entry to the market – the power of the three big raters is purely in the use of their results.

7. Frances_coppola

6 Watchman

Part of the reason for the dominance of ratings agencies is the provisions of Basel II, which specify that financial institutions should rely on ratings from CRAs when considering the risk weightings to apply to various forms of debt, including sovereign and corporate debt.

Frances,

Thanks – so my supposition that this is a government (or supragovernmental) regulatory thing appears correct then.

The problem is pretty clear – government in some form promotes these rankings and effectively closes the market, and therefore the rankings companies are protected from failure. A pretty clear case of government causing the problem…

“The three credit ratings agencies were key enablers of the financial meltdown. ”

In the old familiar pattern of no matter what the issue is someone else is to blame. People too lazy to do their own research are only to happy to blame others for their laziness.

“But, very soon, the chancellor may well find himself as the only person believing the agencies’ hype. ”

The credit rating agencies were ‘ key enablers of the financial meltdown.’ No one believes the rating agencies. Don’t you think you are contradicting yourself?

Only a few marginal buyers who are restricted to certain ratings buy sov. debt based on the CRA. Even where they are restricted to only buy triple A, they would only sell if two of the main agencies downgraded. Most buyers look and judge the debt on where the credit default swap is trading. The CDS is the rating that counts and the CRA are only a media obsession. If a country is downgraded then it almost always happens after a blowout in CDS, so the CRA are only following what has already happened in the market.

” Despite the fact that inaccurate credit ratings were a primary cause of the crisis…”

Co-operative financial services must have made a fortune from knowing that ratings were inaccurate. Did they? People who are wise after the event are two a penny. Too many lazy people exposed to risks hugely correlated was a more fundamental cause.

8. Watchman

“The problem is pretty clear – government in some form promotes these rankings and effectively closes the market, and therefore the rankings companies are protected from failure. A pretty clear case of government causing the problem…

- beware of letting your ideaological presumptions driving your conclusions.

The ratings agencies lobbied hard for Basel II to require financial services to be rated by them, as it was immensely profitable for them to do so.

It is investors who promote these rankings: They need it to establish risk in their investment. But if all investors are essentially build their investment strategies on the opinions of just three organisations, who may well use similar methodologies for evaluating risk, then the chance for the whole pack of cards collapsing is very much greater.

The free hand of the market will “regulate” by creating these sorts of calamaties, its just it doesn’t care that it is a calamity, and it does not bring about equilibrium.

In 2008 “Too Big Too Fail” policies stepped in, as when we are standing on the precipice, as a species we just don’t believe in Laissez Faire. As Shumacher said, what we need is a system that reduces the impact of human wickedness.

Part of the reason for the dominance of ratings agencies is the provisions of Basel II, which specify that financial institutions should rely on ratings from CRAs when considering the risk weightings to apply to various forms of debt, including sovereign and corporate debt.

Sovereign debt at zero risk, is that correct?

11 – OECD Sovereign debt at least.

And Basel III retains the role of the ratings agencies in determining how risky capital assets are. On the other hand Dodd Frank fobids banks from using rating agencies for that purpose. Which, given that the US is signing up to Basel III, will make US banks’ compliance departments rather fraught places, I’d have thought.

davidh,

A free market would discard these ratings agencies if it was proven that their ratings were inefficient. But if, as here, the market is not free because government (and I am happy to accept that government was led in this decision by investors and the rating agencies – all of whom have more to fear from a free market) gives certain agencies a particularly favoured position, then my point stands.

You seem to think that international finance is a free market – but it is the exact opposite. Think of the regulatory burderns it involves and you will see why. And the clever thing, from the point of view of the big banks, is that they want it that way, and see people arguing either for their right to trade in a regulated environment (i.e. with less competition, and therefore less need for innovation) or for government control over the industry (i.e. less competition or innovation, but with them still able to make money with the risk taken by the government).

There are around 150 credit ratings agencies. There are 9 officially recognised ones in the US alone and many more working unrecognised in smaller markets.

This just isn’t a monopoly.

Tim,

It is an oligopoly in terms of the officially recognised credit agencies though (it clearly can’t be a monopoly, as there are three, not one…).

Western governments have written laws requiring people to pay attension to what the ratings agencies say. They were certain the this was a good idea, right up until the point when the agencies started to be sceptical about the creditworthiness of western governments.


Reactions: Twitter, blogs
  1. leftlinks

    Liberal Conspiracy – The backlash to Credit Ratings Agencies gathers steam http://t.co/AQ0Ze85a

  2. Stephen Brown

    The backlash to Credit Ratings Agencies… http://t.co/lqN84XHY

  3. Marie Paludan

    The backlash to Credit Ratings Agencies gathers steam | Liberal Conspiracy http://t.co/PEZrOOuj via @libcon

  4. Ben Mitchell

    Backlash against credit agencies continues: @libcon http://t.co/1GNayGYb, by me.

  5. Ben Mitchell

    The backlash to Credit Ratings Agencies gathers steam http://t.co/Xu0GdXbq

  6. Suzie Que

    The backlash to Credit Ratings Agencies gathers steam | Liberal …: The backlash to Credit Ratings Agencies gat… http://t.co/OYKbKODR

  7. Noxi

    RT @libcon: The backlash to Credit Ratings Agencies gathers steam http://t.co/DRAGPetV

  8. Ravi Subramanian

    Backlash to Credit Ratings Agencies gathers steam http://t.co/E0ASKA1w < about time: their failures contributed hugely to 2008 global crash

  9. CW Poole

    2 Good news for a change! The backlash to Credit Ratings Agencies gathers steam http://t.co/NiG9pp8P

  10. CW Poole

    Good news for a change! The backlash to Credit Ratings Agencies gathers steam http://t.co/NiG9pp8P

  11. UK Credit Rating: Fitch Downgrades Economic Outlook To ‘Negative’ « Dr Alf's Blog

    [...] The backlash to Credit Ratings Agencies gathers steam (liberalconspiracy.org) [...]

  12. Stephen Brown

    The backlash to Credit Ratings Agencies gathers steam | Liberal Conspiracy http://t.co/1LSAUjbk via @libcon





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