The web of intrigue behind Deven Sharma's downfall

Pulitzer Prize-winning columnist Thomas Friedman famously said in 1996 that there were “two superpowers in the world.” One was, of course, the US. The other, he said, was the bond rating agencies.

“The United States can destroy you by dropping bombs, and Moody’s can destroy you by downgrading your bonds,” Friedman noted with more than a touch of exaggeration. “And believe me, it’s not clear sometimes who is more powerful.”

Clarity on that point may well come about soon enough.

Earlier this month, rating agency Standard & Poor’s itself dropped a bombshell of sorts, when it downgraded the sovereign rating of the US from the top-notch AAA grade and set off panic waves around the world. To many, the powerfully symbolic move effectively signalled the beginning of the end of US economic supremacy.

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It also triggered a reflexive effort by political establishments around the world to tame the rating agencies , which - in the estimation of many - have become more powerful than god.

When earlier today, Standard & Poor's announced that its president Deven Sharma , who had been publicly defending the controversial ratings downgrade, would resign, the reflexive response was, consequently, to see the two events as related.

Rating agency downgrades the US: the political establishment secures agency’s head. That was the narrative that appeared to sum it up most succinctly.

Financial Times reported, citing “people familiar with the matter”, that Sharma’s departure was unrelated to the downgrade or the ongoing investigation by the Justice Department into rating agencies’ failure to see the 2008 financial crisis coming.

But that only appeared to validate the dictum never to believe anything until it’s officially denied.

The ‘smoking gun’

[caption id=“attachment_67172” align=“alignleft” width=“380” caption=“Standard & Poor’s president Deven Sharma, who had been publicly defending the controversial ratings downgrade, is set to resign. AFP”]  [/caption]

In fact, the trail of events leading up to Sharma’s resignation points to darker forces at work in the entire episode. It has all the elements of a suspense thriller, and makes for a gripping narrative of international intrigue.

Just last week, the cyber-hactivist group AntiSec, which spearheads a movment against the computer security industry, hacked into the email account of a senior official at Vanguard Defence Industries (VDI, a Texas-based manufacturer of unmanned aircraft - or drones - used in war), and released thousands of emails in the public domain.

AntiSec said that the emails it had secured contained internal meeting notes and contracts, “schematics, non-disclosure agreements, personal information about VDI employees” and counter-terrorism documents classified as “law enforcement sensitive” and “for official use only.”

But amidst all those thousands of emails, AntiSec also stumbled on a “smoking gun” that linked up to the rating agency S&P’s.

It came in the form of an email sent out by VDI senior vice-president Richard T Garcia (whose account had been hacked into by AntiSec). In that email, written on 25 April - three months before S&P’s rating downgrade, Garcia refers to “advice” provided by a wealth management advisor at Merrill Lynch that Standard and Poor’s “may lower the credit rating of the US government.”

In other words, the email raised the suspicion that people outside Standard & Poor’s had advance notice of the downgrade action. Under the Credit Rating Agency Reform Act of 2006, Standard & Poor’s could see its licence registration revoked if it is established that it leaked information about any pending downgrade before making that information publicly available.

It’s possible to argue of course that anyone who had been following the months-long debate over the debt ceiling crisis in the US would have seen the downgrade coming. But in fact, the wealth of additional information in Garcia’s “smoking gun” email raises the bar of suspicion even higher.

The email noted that a downgrade action from S&P’s “could cause a run on US banks that will affect the Federal Reserve.”

More significantly, it said: “They give the US Govt 2 years to correct the current situation, which they believe both the Republican and Democratic solutions do not do enough and both parties may make this a political situation for the 2012 Presidential election and never come up with a answer to correct the situation within the two years set by Standard and Poors.”

In other words, the email mapped out with amazing accuracy the argument that S&P’s eventually laid out to justify its downgrade - tracing its action to the political gridlock in Congress. Curiously, that political gridlock happened only months after the 25 April email.

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Rating agencies’ policy agenda

The suspicion that rating agencies were only performing “guard-dog service to the world’s bankers” has always been around, and their appalling role in the lead-up to the 2008 sub-prime housing crisis only served to strengthen those suspicions. Trenchant commentators have observed that they weren’t just wrong in giving AAA ratings to toxic assets; they were actually instrumental in creating the policies that led to the financial meltdown.

For instance, Matt Stoller, a fellow at the Roosevelt Institute, says that rating agencies aren’t just incompetent or greedy, they actually have a policy agenda. And Standard & Poor’s is the most aggressive of the three agencies, according to Josh Rosner and Gretchen Morgenson, authors of Reckless Engagement: How Outsized Ambition, Greed and Corruption led to Economic Armageddon.

Stoller recalls that in the 1990s, Canadian banks used S&P’s and Moody’s to threaten a sovereign rating downgrade unless entitlement programmes - healthcare and unemployment insurance - were slashed.

Similarly, he argues, even in the current political tussle in the US over required spending cuts to keep within the debt ceiling, S&P’s “goal.. is to ensure that there is a bipartisan set of spending cuts to social programs that benefit ordinary people.”

The downfall of Deven Sharma may be only the outcome of all the bad karma that S&P’s has accumulated over the years. Yet, his replacement by the COO of Citibank, a bank whose “ existence is inextricably tied to America not seeing any more downgrades” only signifies that the bankers’ hold on S&P’s remains as firm as ever.

Friedman’s point about who is really more powerful - the US or the rating agencies - may have been finally settled.