S&P, Moody, Fitch: The politics of rating agencies

Last week, as financial markets in Europe and around the world tumbled on fears that Spain and Italy were perilously close to having their sovereign rating downgraded, Italian authorities responded to the bad news in bizarre fashion: by shooting the messenger.

Italian police raided the Milan offices of S&P and another leading rating agency Moody’s, which had flagged the risk of a rating downgrade, to investigate whether they had any role in the market turmoil. The chief prosecutor said his office was checking if the rating agencies “respect regulations”.

Later that week, after S&P went ahead and stripped the US of its top-notch AAA rating following the failure of Congressional leaders to lay out a credible roadmap to address the long-term debt problems, US lawmakers are resorting to the same strategy of giving the dog a bad name and hanging it.

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The felt need to “shoot the messenger” who brought bad tidings to the US has ironically brought together the two bickering political parties onto a common platform. The same leaders who for weeks and months have been bickering in the most partisan manner, dragging the country to the brink of a debt default, are now working in tandem to slam rating agencies and defang them.

A US government proposal being contemplated would require credit raters to disclose “significant errors” in how they calculate their ratings, reports Reuters .

Democrats and Republicans in Congress are teaming up to put S&P in particular under investigation and restrict rating agencies’ influence in financial markets.

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[caption id=“attachment_58039” align=“alignleft” width=“380” caption=“Ratings agencies are far from infallible. Miguel Medina/AFP”]  [/caption]

Ratings agencies are of course far from infallible: in 2008, they came in for much justified criticism for their having been blind to the sub-prime housing bubble, and to the underlying risks of the complex financial instruments that they rated highly but which collapsed spectacularly.

Then, when financial markets went into a downward spiral, the rating agencies compounded the problem by speedily and aggressively downgrading the financial instruments, which only hastened the downfall of the financial institutions that were holding them.

And ahead of last week’s downgrade, the US Treasury Department alleged that S&P had miscalculated and overstated long-term US debt of the order of $2 trillion. S&P acknowledged that it had revised its debt projection numbers downwards after discussions with the Treasury Department, but went ahead with the downgrade anyway, saying that its view on the US political establishment’s inability to address structural problems with the US public finances was unchanged.

S&P president Deven Sharma has pointed out that when seen from a historical perspective, his agency’s downgrade call will be seen as the right risk call.

Yet, having rightly faulted rating agencies for not doing their job in 2008, governments in absolute denial over the perilous state of their public finances are now working overtime to discredit them for, if anything, doing their job.

Last month, European Commission leaders ranted that “American” rating agencies were biased against Europe, and called for the creation of an European agency. (This despite the fact that Fitch is majority-owned by a French company.) After the downgrade of US, they will presumably have no ground to feel reassured that home-grown rating agencies offer any immunity from downgrades.

The business of credit ratings is, in some cases, intensely political. Which is why when China’s state-owned Dagong Global Credit Rating Co applied to the Securities and Exchange Commission last year for registration in the US, the SEC declined it.

In its order denying Dagong’s application, the SEC cited Dagong’s incapacity to produce documents that it required as part of the application process. Dagong claimed that under Chinese law, it was forbidden from disclosing documents containing “state secrets”.

But even from far off, Dagong has served China’s political interest admirably well. Last week, even before S&P made its move, the Chinese rating agency downgraded the US rating , noting that the debt ceiling deal hadn’t quite resolved the larger debt problem that the US faces.Since then, official Chinese media have kept up a barrage of commentaries mocking the “downfall of the US.”

But the bigger point is that one didn’t need rating agencies to point out the blindingly obvious fact that the public finances of the US were in bad shape. America’s structural fiscal decline, particularly since 2001, was plainly evident, as _Firstpost_ noted here . It was only the “exorbitant privilege” that the US enjoyed with a dollar-based global currency system that kept it from going under.

As economist Barry Eichengreen observes in his book Exorbitant Privilege, that standing is not without risk. But, he notes, the dollar will lose its international currency status “only if the US repeats the mistakes that led to the financial crisis and only if it fails to put its fiscal and financial house in order. The greenback’s fate hinges, in other words, not on the actions of the Chinese government but on economic policy decisions… in the United States.”

That’s the risk that leaders in the US and in Europe seem to be in denial about. Even today, they seem excessively preoccupied with shooting the messenger than with dealing with the bad news that the mirror of reality forces them to confront.