The Right Getting It Right

Alex Brummer writes:

The idea that we should allow the credit ratings agency Standard & Poor’s to decide on the creditworthiness of the United States, or for that matter any other sovereign government, is preposterous. Standard & Poor’s and the two other main credit-rating agencies, Moody’s and Fitch, have a long record of making wrong judgments. As commercial organisations, funded by the big banks and corporations, they too often have a vested interest in reaching the conclusions demanded by their paymasters.

Yet during the current sovereign debt crisis, which was sparked last year in Greece and has now spread to Italy, Spain and the almighty United States itself, the pronouncements of these agencies have become regarded as holy writ. And because the markets react to their pronouncements on debt and creditworthiness, they have in their way been as much responsible for the volatile trading on share, bond and foreign exchange markets as any of the irresponsible actions of governments. When trading resumes today, for example, we can expect Standard & Poor’s decision to downgrade America from the coveted ‘AAA’ rating to ‘AA+’ to have a savage impact.
The question is why? And the answer is that the credit rating agencies are now seen as the only arbiters prepared to spell out just how serious the global debt crisis really is.

Europe’s leaders have lost all credibility after a series of sticking-plaster bail-outs which have failed to save countries in the eurozone. The U.S. government’s disastrous delays in tackling its budget crisis means its statements of reassurance are not worth the paper they are written on. Meanwhile, the official, taxpayer-funded organisations charged with policing global financial affairs – the Paris-based OECD, the World Bank and the International Monetary Fund – are mistrusted because they have been so slow and timid in their reactions to the debt crises that have brought the world economy to the precipice once again.

As a result of all this, the credit-rating agencies and their pronouncements are given far more authority than they deserve. The truth is that the agencies have extremely chequered reputations. In the run-up to the two-year banking crisis that began in 2007 with American sub-prime mortgages – in which vast quantities of loans were made by U.S. banks to homeowners who could never pay them back – these very agencies declared toxic sub-prime loans to be of the finest quality, deserving the gold standard ‘AAA’ rating.

Why? After looking into the matter, the view of the U.S. Senate Permanent Sub-Committee on Investigations was that the agencies, including Standard & Poor’s, were in the pockets of Wall Street and the banks. Those who came up with the sub-prime ratings had enjoyed lavish entertainment courtesy of bankers and were paid handsomely by them for their reassuring verdicts. Senator Carl Levin’s committee concluded that the agencies’ failings had not only helped to hide the true extent of the problem, but had also meant worthless sub-prime loans spread through the entire financial system. ‘AAA ratings were attached to products later revealed to be little better than junk,’ said the committee.

We should not be surprised by this damning verdict. After all the very same agencies were still providing the U.S. energy company Enron with a top rating up to three days before it collapsed in the world’s then biggest industrial bankruptcy. They also gave a clean bill of health to Fannie Mae and Freddie Mac – semi-official, but privately owned U.S. bodies set up to expand home ownership and the availability of mortgages – despite warnings from the legendary American investor Warren Buffett that they were broke. Within days Fannie and Freddie were taken into public ownership by President George W. Bush’s administration.

It is partly in response to these notorious mistakes that the rating agencies have become much more aggressive in delivering downgrades to both corporations and nations. European leaders were furious that, when Portugal was seeking to resolve its budgetary problems last year, Moody’s, out of the blue, delivered a devastating downgrade, leading to charges from the country’s leaders of ‘economic terrorism’. The subjective nature of Standard & Poor’s downgrade of U.S. debt is reflected in the fact that its two rivals, Moody’s and Fitch, announced last week that they were not minded to change the ‘AAA’ rating.

In truth, as holder of the world’s reserve currency, America has less to fear from a downgrade than almost any other country in the world. Precedent suggests that a downgrade will not necessarily be critical for the U.S. dollar. Japan, for example, is currently rated at ‘AA’ (two notches down on Britain and one below the U.S.) yet its currency the yen is still among the most sought-after in the world. S&P’s downgrade may look like a poke in the eye for the United States. But with luck, it could in the end damage the future credibility of the credit rating agencies – they are in more urgent need of reform than America itself.