Either guardians or villains

Earlier this year, Dagong, China’s rating agency, twice downgraded the long-term debt of the US government. The world hardly noticed, even though China holds 46 per cent of America’s sovereign debt. Earlier this month, Standard and Poor’s stripped the US from its AAA rating. The stock markets tumbled and President Barack Obama insisted “this is the United States of America. No matter what some agency says, we will always be a triple A country” (The Guardian, August 8).

The downgrade, the first in American history since 1941, was a severe blow to Mr Obama’s economic stewardship. Contrary to expectations, however, the demand for US Treasury bonds actually increased. These are not normal times. Europe is bedevilled by currency and fiscal problems, Japan is recovering from the earthquake’s aftermath while the US economy remains anaemic.

For the first time since World War II, the interest rate for US short-term Treasury bills fell to below zero while that on 10-year US bonds fell to 2.36 per cent (a level that is associated with periods of economic stagnation). Investors feel insecure and are afraid that the global economy may double-dip into a recession.

The downgrade has hurt the national pride of the world’s prime economic powerhouse more than its coffers. At worse, it will raise the US’ annual debt servicing costs by some $100 billion. S&P’s decision was meant to put pressure not only on President Obama but also on the Republican Party.

The world’s largest sovereign rating agency stressed the lack of political willpower in Washington to correct the fiscal mess. When the US Treasury found a miscalculation of $2.1 trillion in the agency’s workings, S&P’s insisted that their decision was based on political rather than economic considerations.

The question that arises is how come a rating agency can be so powerful so as to challenge the standing of the US? What gives it such a right? There are about 100 ratings agencies in the world but 95 per cent of the sovereign (government) market is in the hands of the Big Three agencies: S&P’s, Moody’s and Fitch.

Major investing institutions often rely on agency ratings rather than carry out their own independent valuations. These agencies have assumed a “quasi-official” status as certain funds are obliged to hold only certified grades of investments. The EU refers to credit ratings in various directives including the Basel II guidelines (on banks’ capital requirements) and Solvency II (for insurance firms).

These agencies’ predictions tend to be self-fulfilling prophecies; markets react as herds with a down-rating compounding the difficulties of a borrowing nation or corporation. Also, investor associations have repeatedly criticised the rating agencies’ business model where clients have to pay the agencies to be rated. The track record of the rating agencies is far from impressive; too often they fail to foresee severe financial crises as with Argentina, Russia and Asia. The US Financial Crisis Inquiry Commission severely reproached the Big Three agencies for their role in the 2007 financial meltdown and, in particular, their reluctance to downgrade assets they had rated highly.

The EU is suspicious of the Big Three and accuses them as being pro-US. The Europeans have been incensed by the way that these agencies downgraded to junk status Greek, Irish and Portuguese government bonds. The EU has been vociferous about the need to control what they see as a powerful cartel that can influence investor opinion more than the International Monetary Fund, the European Central Bank and the European Commission, all put together.

The EU is committed to strengthen its oversight of these agencies. A pan-European watchdog is being set up having the power to oblige rating agencies to justify their decisions by giving details of their analyses and criteria. The Big Three say they welcome these initiatives as the market will gain confidence from consistent rules for credit rating, greater transparency and better management of conflicts of interest.

The EU is proactively encouraging other rating agencies to challenge the hegemony of the Big Three. There have been repeated calls to set up a European rating agency. It remains unclear as to who will guarantee the independence of such an agency, given that the euro crisis has shown that even the mighty European Central Bank is not immune to political pressure. Such initiatives have induced various analysts to accuse the EU of political interference and of seeking to undermine the independence of these agencies.

The present financial system has become an exploitative tool that enables a few people to become super rich at the expense of the rest of society. The recent financial and economic turmoil presented a unique opportunity for global leaders to overhaul the system. Little has changed as the vested interests are too strong.

Unless radical and equitable solutions are found, there is a possibility of more people taking to the streets to defend their right for a decent standard of living. Will the ratings agencies prove to be the guardians of the financial system or the villains that will accelerate its demise?

fms18@onvol.net