The rating agencies are not the politicians’ best friends at the moment. When on Friday, January 13 they downgraded nine of 17 eurozone economies, but retained the AAA of Britain, politicians in Europe cried foul and hinted at an Anglo-American conspiracy against France. But blaming the rating agencies for all that is rotten in the present eurozone economies is not justified.
EU leaders should tackle the underlying weaknesses in their economies- John Cassar White
There is no doubt that rating agencies face an issue of lack of credibility. Their incompetence and cynicism exposed by the 1997 Asian financial crisis and more dramatically by the 2008 global financial crisis are good enough reason to challenge their assessments and timing. Christian Noyer, president of the Banque de France accuses the rating agencies of giving more weight to political than economic factors. He adds that “the rating agencies were one of the motors of the crisis of 2008”.
The European Union has reacted to the Friday-the-13th misfortune by vowing that it will introduce tough regulations to control the rating agencies. European Commissioner Michel Barnier, a former French Foreign Minister and Agriculture Minister, is determined to introduce a reform package that would limit the rating agencies’ freedom of expression on “prevention disorder” grounds. But not everyone in the EU is welcoming these proposals. Five commissioners – including those from the UK and Sweden – are reported to be concerned that “such restrictions could backfire and damage fundamental rights”.
While it is true that rating agencies are no shining examples of professionalism, EU political leaders must acknowledge that the eurozone crisis is indeed their own doing. What is even worse is that a credible solution has yet to be crafted and until this is done financial markets and rating agencies have every justification is being sceptical about the future of the eurozone.
The austerity measures being imposed by the stronger eurozone countries on the periphery economies are likely to reduce rather than increase economic growth which is the only way that the eurozone can once again experience healthy growth. As economic growth falters, tax revenue will fall and budget deficit problems become more endemic. The risk of contagion will spread and even the stronger economies will not be immune to deflationary pressures.
Even if rating agencies have repeatedly shown inconsistency in their judgements on the risks of uncontrolled public finances, they are right in pointing out that the solutions proposed so far by the eurozone leaders are unlikely to solve the financial crisis that is affecting the EU.
The Guardian correspondent Hu-Joon Chang is right when he says: “The eurozone, and more broadly Europe, is slowly strangling itself with a toxic mixture of austerity, and a structurally flawed financial system. Without a radical rethink on the issues of budget deficit, sovereign bankruptcy and financial reform, the continent is doomed to a prolonged period of turmoil and stagnation”.
The complexity of financial markets makes the existence of rating agencies a necessity. The grading of credit risk, whether made by rating agencies or by other organisations, is at the basis of capital markets. In the good old days when bankers operated mainly locally and knew all their clients and understood their businesses, they could express fairly reliable opinions on the creditworthiness of these clients.
Now, as a result of deregulation of the financial sector, investors buy and sell financial products issued by companies and countries that they do not really understand. To make things worse, most of these investment products are often complex and composite making them very difficult to assess the inherent risk of owning them. So the rating agencies have become almost indispensable to keep the present financial system glued together.
The financial world’s dependence on rating agencies will only be reduced when reforms are undertaken to simplify the global financial system. Financial regulation can reduce our dependence on the often subjective judgement of rating agencies. But ultimately a more radical reform is needed to ensure that financial markets exist to support the real economy of countries rather than become a parallel economy.
Rather than blame rating agencies for the current eurozone problems, EU leaders should start to tackle the underlying weaknesses in their economies. Years of irresponsible profligacy in public finances in most eurozone countries cannot be rectified through a crash diet of bitter austerity.
As the German Finance Minister, Wolfgang Schauble, righty said: “It is up to the Europeans to solve our own challenges”. From where we stand today, I see little chance of this happening in the near future.
johncassarwhite@yahoo.com