The headline says ‘Europe declares war on rating agencies‘:
Wolfgang Schauble, German finance minister, said there was no justification for the four-notch downgrade or for warnings that Portugal might need a second bail-out. “We must break the oligopoly of the rating agencies,” he said.
Heiner Flassbeck, director of the UN Office for World Trade and Development, said the agencies should be “dissolved” before they can do any more damage, or at least banned from rating countries.
Now ponder that for a moment… what is a ‘rating agency’? It is a company that states an opinion regarding credit worthiness. And those opinions are only significant if people who make investment decisions think the opinions in question actually reflect reality, i.e. the opinion has some credibility.
So what these quoted members of the political class are calling for is banning credible opinions about the consequences of decisions by, er, people like themselves.
Astonishing. And in reality rating agencies have a history of excessive optimism, only downgrading ratings long after the dots were joined by anyone who has been paying attention.
Shoot the Messenger!
Twas ever thus.
To be fair, a four-notch downgrade is pretty extraordinary.
Still, it is instructive that someone as grossly and obviously ignorant of basic economics and investment principles as Heiner Flassbeck should be director of the UN Office for World Trade and Development. That pretty much tells you all you need to know about the quality of that office.
Those nasty non-government controlled companies. Still, a bit hypocritical considering governments rely on private money for loans.
Who gets to buy a yacht with the profits of supplying black market security ratings to corporate treasurers?
Not as many yachts will be bought that way as with the profits of selling dodgy investments to the treasury departments of local authorities across the EU, though. Not that they are necessarily alert enough to pay attention to ratings, markets, or even government circulars, anyway… see under: Three Rivers District Council, Kent County Council, Transport for London …
One problem is that these private sector agencies, such as Standard & Poor’s, Moody’s, Fitch, and the rest, suffer from serious conflicts of interest. On one hand, they are paid by borrowers to rate their debt, and not surprisingly, the borrowers will want to get the best rate possible, so as to get the lowest borrowing cost. On the other, lenders will want these agencies to do a sharp job, so they don’t end up lending money to weak entities.
In truth, the ratings of these agencies, while useful, are no substitute for good judgement on the part of lenders and borrowers.
As for the bleatings of governments, if they want to get a better score for their credit, then they know what to do: run public finances intelligently. Fat chance of that happening.
Strange – one would rather expect them to be paid by lenders, no?
So spoken by an EU stooge and a UN stooge.
Aw, what’s the matter, it’s just the beggining of the death throes of the globalist dream after all.
Demanding ratings agencies rate junk higher than it logically should be. Is 2008 so far distant?
Alisa, it is the borrowers, but it doesn’t matter as there is a conflict either way. Borrowers want the rating to be optimistic, lenders pessimistic.
If I might quote Andrew Bierce here:
Impartial – the state of seeing no advantage to oneself from favouring either party.
Now how on earth could the EU or the UN or for that matter the U S “dissolve” rating agencies?
How could censorship be effective, given the international access to the U S information systems?
These guys are really flailing about to deal with the recognition that the attempts to use the instrumentalities of governments (and other super-impositions) to effect disfunctions in the distribution systems of the various economic areas have not only failed, but have generated further disfunctions.
Let’s imagine Flassbeck got his way. What does he think would happen? “The ratings agencies that were saying Portuguese bonds were bad have been banned from saying such things. Now I can finally put all my money in Portuguese bonds!”
The article and most of the comments are missing an important fact. Ratings are no longer just a piece of information that lenders can use to determine if they should buy a particular instrument. They are written into contracts of various funds – and I believe into legislation (for instance what is counted as different levels of capital in banks). Some pension funds can only hold A or better rated products – as soon as one gets rated less than A they have to sell – which of course can lead to a pretty self fulfilling prophecy. This gives the ratings much more importance than simple pieces of information – which has largely been driven by governments trying to eliminate risk.
I don’t think that’s true, unfortunately. IIRC, in order to satisfy their capitalisation requirements, banks have no choice but to take the rating agencies’ opinions into account.
I do not know the details of this situation, though – surely someone better informed can correct me.
I’ve discovered a cure for cancer. Just ban doctors from telling people they’ve got it.
That’s true to a certain extent, Andy (although in the US, at least, some of those “mandatory investment” laws are being eliminated or relaxed), but the fact remains that the security only has to have an investment grade rating from one of the agencies. As long as one of the others retains that grade the investment is still OK. And if all of them downgrade to sub-investment grade status that’s a pretty good sign that the security is, in fact, junk and should be avoided by public funds or require more capital by banks.
Roue, that’s not accurate. Lenders don’t want ratings to be “pessimistic”, they want them to be accurate. And to the extent there is the “conflict” you perceive (I don’t) it’s mitigated by competition among the agencies. And there are more than just the Big Three: China now has its own (Dagong), and there are several more. All depend upon the confidence of investors to remain in business, and all serve to keep a check on the others.
Jonathan, the payment of fees by private issuers does pose a conflict of interest, as is now well known, but as far as I know no sovereign issuer pays any such fees. Thus that conflict does not apply to Greek or other national debt, which is what these bureacrats are whining about.
I’ll bet Herr Flassbeck was cheering when Wikileaks was releasing masses of US defence secrets.
But heaven forbid that mostly-US-based ratings companies publish their considered opinions about the relative risks of European government bonds. That – must be kept a secret.
The willingness of these statist tools to deny reality never ceases to amaze me – as though the European debt crises were caused by people publishing carefully-considered analyses of the risks of what was being offered. Standard and Poors and Moody’s and all the rest live or die by the quality and accuracy of their predictions – leaving aside their vested interests, their over-riding vested interest is in being reliably right. Muzzling them would mean that investors would have to take the word of politicians and central bankers for the relative risks of their debt offerings. No conflict of interest there, oh, dearie me, no.
llater,
llamas
Basically, they want to ban free thinking, free speech.
I now see what confused me: I tend to think of borrowers as private persons, and of lenders as institutions (such as banks) – whereas in this case it is the other way around.
There was an interesting to and fro between Jean-Claude Trichet and questioners at the ECB press conference this afternoon. ‘ Small Oligolopist Structures’ was thrown at the ratings agencies by Trichet, but who would decide between a “default” selective default” etc., became ever less clear.
More on my blog, particularly an interesting market launch by Hennessy at Frankfurt Airport.
I don’t know about the rest of you fine people, but very few of my life decisions are based on bond ratings. These things are interesting and useful mainly to those in the public finance business, who are presumably a relatively small number of very well-informed people – such as Herrs Schauble and Flassbeck. Therefore their argument doesn’t even seem to be the bad argument of “Don’t tell the public because they will panic”. It is more, “Don’t tell US or WE’LL panic”. Gah.
Surelin, that puts you into the same category as “Jane” on another thread concerning the discussion about US taxation of its expatriots. She doesn’t think it affects her, so she doesn’t care about the issue.
Bond ratings do affect you, albeit indirectly, and it behooves you to know something about them. They directly affect the interest rate paid on the bonds, so as a taxpayer of any sovereign entity which issues them (i.e., every country on earth) it affects how your taxes are used. When ratings go down the value of existing bonds goes down, too, so it affects the capital and earnings of any bank which holds them. And, as has been noted already, it can force the liquidation of some holdings, which also affects the entites which had held them (pension funds, money market funds, etc.). Finally, if enough of those bonds are devalued (i.e., a Greek default) it could prompt a governmental bailout of the banks holding them, which also affects you as a taxpayer.
This is an important issue for the entire global economy, not merely some abstruse technical matter which only affects investment funds.
You folks just don’t understand.
If you talk about something, point it out in public, bring it up in polite company, then it exists.
If you just shut up and don’t mention any of these uncomfortable problems, why, they don’t really exist at all, and can be ignored for a little while longer.
And, besides, when the trouble actually does come, and can’t be ignored any longer, it’s always somebody else’s fault. Some greedy speculator or unscrupulous banker did it. Everybody knows that ahead of time.
Really, if you don’t know the rules of the game, you shouldn’t try to play at all.
Aren’t they also trying to prevent the Hedge fund managers from pointing out a few home truths too?
Laird,
Roue, that’s not accurate.
You’re just poking me with a blunt stick, aren’t you? You yourself say ratings set interest rates. Lenders would like more interest. Therefore a mild and predictable pessimistic bias in the ratings is in their interests as it will give them a higher rate of return than the actual risk would indicate. How is that contentious?
I perceive a conflict but you don’t? Yet in your third paragraph the payment of fees by private issuers does pose a conflict of interest duh?
Everybody has an interest in the rating therefore whoever pays for it, there is a conflict of interest. And the biggest payer by far is the US government, indirectly, by the protected status of the big three. Luckily the US is run by philosopher kings who would never dream of exploiting this influence to their advantage.
Perry and the others (such as Very Retired) are correct – the Ratings Agencies have a record of downplaying (or ignoring) real dangers – not inventing nonexisting dangers.
Because the powerful believe that if a problem is not discussed it does not exist (the denial of objective reality – to be found in the Pragmatist School of Philosophy and other places).
In the United States at least things are (as always) complicated by regulations.
Ratings Agencies are licensed (which is why there is a small cartel), and companies are (by the regulations) forced to take into account their ratings.
So if something is rated triple A……
Europe may be planning similar things – in order to get “cheaper borrowing” (and so on).
Remember the problem is not the Welfare State (or even credit bubble monetary policy – leading to bank credit expansion) – no it is even financial people demanding “high interest rates” and so on.
Roue, I still disagree. Sure, investors want a higher yield, but you’re suggesting that this incents the rating agencies to put a lower-than-justified grade on a specific security. But in addition to being completely contrary to the agencies’ need for investor confidence in their ratings, it’s just not necessary. If an investor wants the yield of an “A-” security he’ll just buy one (there’s no shortage of them). Why try to have an “A” security misgraded to achieve the same result?
Or are you saying that the bias is across the board? If that’s true, then the rating of every security will be artificially depressed, and the markets will adjust the yields back to where they should have been in the first place. No one gains from that.
In the end, all that you’re arguing for is to have the issuers pay the agencies to offset that perceived “negative bias”. The current system, in other words.
I do agree that the payment of rating fees by private issuers can create the possibility of a conflict of interest. I don’t think that it actually does in most cases, however. When I’ve dealt with rating agencies (which admittedly hasn’t been for a number of years) they held all the power: we structured our securities (subordination levels, etc.) to meet their demands so we could attain the desired rating. I think that’s true for most issuers, all except the very largest ones such as Goldman Sachs, etc. Those control so much of the new issuance market, and pay such huge amounts of rating fees, that they do have an influence on the agencies’ behavior. That’s a concern. But I think it would still be a concern even if they didn’t pay the rating fees directly, as they still would wield enormous power over the markets. Other than encouraging rating competition I don’t think there’s a solution to that.
Incidentally, this is merely a response to your “conflict of intrest” comment. Don’t read any of it as a blanket defense of the rating agencies. Their reluctance to downgrade sovereign debt is well known; at best they’re a lagging indicator. Also, I’ve been in the trenches and seen their analytics of mortgage-backed securities (before the collapse of 2007) and it was utter crap. They were thoroughly clueless.* As I’ve said here before, more than once, they didn’t get anywhere near enough of the blame for the market collapse. So I don’t for a minute take their pronouncements as gospel. But there is a difference between incompetence and conflict of interest, and in my opinion the former is by far the larger issue.
* For example, they couldn’t grasp the inherent problems of negative-amortization or balloon loans; they assumed that loans with LTV ratios higher than 100% would perform exactly like those with lower LTVs; and they refused to model any scenarios where property values declined.
Fair enough, Laird. So here’s the hypothetical. You are about to issue a splendid new instrument with very low risk. I am interested in purchasing that instrument. we both use the same ratings agency. Unfortunately for you, I do a great deal more business with them than you do, and I am able to get them to mark you down a notch lower than they otherwise would. I am therefore able to get a higher return than the risk actually merits.
This is just a special case of the general principle that when a third party arbitrates between two competing parties, both of the competitors have a interest in influencing the arbitrator in their direction. Of course this is hypothetical, and in practice multiple agencies make it unlikely.
When it comes to rating sovereign debt, it is reasonable to remember that governments don’t pay to be rated, but the big three agencies do receive a comfortable guaranteed income courtesy of the US government. There is no reason at all to suppose that this does influence them, but it shouldn’t be forgotten, either.
Otherwise we are in complete agreement. The agencies get out clause is that they are providing ‘spot’ ratings, i.e. the chance of default today. Thus whenever something goes wrong, they can reasonably say ‘well, it was alright yesterday’. This is clearly of no use whatsoever to anyone taking a longer than overnight position.
I find interesting that even when you think you are not discussing the market vs. the committee, you find out yet again that you are.
Your hypothetical is certainly possible, although as you say the existence of multiple agencies makes it unlikely (unless, of course, your initials are G.S., but when dealing with them we’re all screwed and usually don’t even know it!). I think we’re pretty much in agreement.