Despite the criticism that rating agencies have endured in the past three years – much of it justified – someone at Standard & Poor’s retains a sense of humour.
Having seen off a half-baked European Commission proposal for some ratings downgrades not to be published at “inappropriate moments”, S&P warned 15 eurozone members of possible downgrades only hours after Nicolas Sarkozy and Angela Merkel had unveiled a new Franco-German approach to the crisis. You don’t get much more inappropriate than that.
Europe’s politicians and bankers were displeased. “A wild exaggeration and also unfair,” complained Jean-Claude Juncker, prime minister of Luxembourg. “These observations arrive completely at odds with events,” said Christian Noyer, president of the Banque de France. “A very politically motivated action,” huffed Ewald Nowotny, the central bank governor of Austria.
Aside from being tactless, however, I cannot see what S&P did wrong. The agencies’ failure in the 2008 crisis was to give a false seal of approval to subprime securities, and then to downgrade them in a rush. As Carl Levin, the US senator, put it: “Mass downgrades hit the markets like a hammer, making it clear that the investment grade ratings had been a colossal mistake.”
So what’s the mistake this time? That Germany and France should not be triple A-rated in the first place? Having complained so loudly that agencies betrayed the interests of the investors that relied on their opinions because they were over-kind to the issuers that paid them, it is hypocritical for governments to demand soft treatment.
There are problems with rating agencies. The big three of S&P, Moody’s and Fitch remain dominant, and both markets and central banks and regulators tend to take their pronouncements too seriously. It is akin to the New York Times theatre critic who can shut a Broadway show with one bad review.
They also have a conflicted business model under which ratings are intended to guide investors but are paid for by companies, and some governments. Efforts at reform to end the incentives to over-rate bonds has come to little so far.
But the wrong response would be regulatory over-reach that has the perverse consequence of raising the barriers to entry and entrenching the leaders. If angry European politicians and bankers do not watch out, they will encourage such a reaction. The best thing they can do to prevent agencies exerting such power is to cease promoting them.
The silliest observation was Mr Nowotny’s that “politics must set its own priorities”, as if S&P had a duty to keep quiet while politicians once more argued over a eurozone rescue. As S&P noted tartly, investors dislike the “reactive and insufficient policy responses so far”.
If politicians don’t want investors to criticise their actions they should stop borrowing money. All that S&P and others do is to offer an opinion on the likelihood of sovereign bonds being repaid, which is a legitimate activity. Issuers pay for ratings because, in the long run, it deepens the pool of investors.
The question is how well they do it, and S&P’s intervention suggests a valuable degree of independence from issuers – in this case, governments – and a willingness to stick its neck out. S&P has warned of the risk of eurozone defaults since it first downgraded Greece in September 2004, and that hardly looks like bad judgment now.
S&P attaches more weight than Moody’s to political risk – the willingness to repay rather than the financial ability to do so. It found that US governance had become “less stable, less effective and less predictable” when it downgraded the US from triple-A in August. Anyone watching the Republican primary contest can observe that.
Unlike their performance on US mortgages, the agencies have a fairly sound record on sovereign debt. Not only have they been ahead of investors in signalling concern about the eurozone – bond spreads widened long after Greece, Italy and Spain were first downgraded – but every sovereign that has defaulted since 1975 has lost its investment grade at least a year previously.
So there is no reason for eurozone politicians to take the sovereign debt crisis as a justification for dictating how agencies operate. Indeed, the International Monetary Fund and the Financial Stability Board have both suggested the opposite – that central banks and regulators stop “hard-wiring” ratings into policy.
The agencies remain a protected species because central banks use ratings from officially-approved agencies for purposes including deciding which collateral to take from banks and assessing the riskiness of assets. The Dodd-Frank Act has started to remove this imprimateur in the US.
Unfortunately, having placed the agencies under the supervision of the European Securities and Markets Authority, the European Commission is going in the opposite direction. Michel Barnier, the internal market commissioner, has unveiled a raft of proposals to control what agencies do – including his now-abandoned plan to suspend their ratings in “exceptional circumstances”.
He says he wants to open up the market by, for example, imposing mandatory rotation of a company’s ratings but his proposals would place them on a par with “too big to fail” banks. They would become regulated bodies with implicit seals of approval instead of competing equally with other research groups.
Ms Merkel had the best riposte to S&P. “What a rating agency does is its own responsibility,” she said. So it is, and governments that interfere will do more harm than good.
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