Supposed to be Standard, More Often Just Poor
Rating agencies have rightly shouldered much of the blame for the financial crisis, and yet the world still looks to them for guidance on sovereign debt. For example, the Euro, which has now dipped under $1.30, owes part of its lost value to recent credit rating agency (CRA) downgrades of Greece, Portugal and Spain. These countries are clearly mismanaging their national budgets, but given the recent history of CRA blunders it feels a bit ironic to trust them in particular to tell us when a country’s in trouble.
From Fund Strategy:
“Once again, the federal negotiators were begging to be anointed. Imagine going to a religious figure who has been defrocked and asking for absolution!
“A year later, as sovereign debt risks emerge as the latest danger, investors anxiously await credit rating agencies’ (CRAs) position on the debt of Greece, Britain or even America. It is a paradox. Despite an abysmal track record in recent years, those agencies still wield unrivalled power and influence. They remain the only game in town, as regulatory reforms advance at a glacial pace. This discussion attempts to sketch out some of the thorniest areas crying for reform, and then to suggest a few solutions.
“First, the agencies’ business models are riddled with conflicts of interest, says Richard Herring of the Wharton School at the University of Pennsylvania. Although the agencies had originally sold manuals with credit assessments to investors, by the 1970s they had switched to a model whereby issuers paid them instead. Herring describes the mixed incentives of the diverse constituencies: ‘Issuers want the highest rating they can obtain, and prefer to conceal or sugarcoat adverse information to keep their borrowing costs low.’”
Countries like the US and UK right now — when compared to the PIIGS — seem like less urgent risks. Yet, the major debate surrounding US debt remains the increasing risk of a credit downgrade. The world is still at the mercy of credit rating agencies that have more than proved their fallibility. Given the circumstances, we wouldn’t put it past US regulators to find an excuse to take them over.
If you’re interested in learning more, you can visit Fund Strategy to read about the “second rate.”