Credit Ratings Independence Tested

You might have heard that the debt of the country of Portugal was lowered to “junk” status on 5 July, 2011 by Moody’s, one of the three major international debt ratings agencies.  Now various European governmental officials are criticizing the credit ratings agencies, challenging their independence and independent voice.

Here are three quotes from European officials:

Greek Foreign Minister Stavros Lambridinis said: “The agencies’ actions in the debt crisis [had] been ‘madness.’ “

German Finance Minister Wolfgang Schaeuble told a news conference he wanted to: “break the oligopoly of the ratings agencies and limit their influence.”

European Commission spokesman Amadeu Altafaj: “The timing of Moody’s decision is not only questionable, but also based on absolutely hypothetical scenarios which are not in line at all with implementation.  This is an unfortunate episode and it raises once more the issue of the appropriateness of behavior of credit rating agencies.”

European Commission President Manuel Barroso said that the move by Moody’s: “added another speculative element to the situation”.  He also said it was strange that none of the ratings agencies were based in Europe.  “[This] shows there may be some bias in the markets when it comes to the evaluation of specific issues of Europe,” he said.

Folks this is absolutely outrageous!  Why?

1. Independent voices are one of the things in short supply in financial markets.  Do we really want gun shy independent voices in the long run?  Hell, do we really want gun shy independent voices ever?
2. The lack of independence on the part of credit ratings agencies was one of the things that led to the Great Recession.  Effectively the folks issuing terrible mortgage backed securities were the same folks paying the agencies for the rating.  Due to the huge volume of transactions taking place, for an agency to issued an unfavorable rating would have hurt future revenues from these heavy issuers of MBS.
3. Credit ratings agencies have come under tremendous pressure from international authorities for their lack of independence.  Now when the heat is on the various governments who dole out the criticisms of credit ratings agencies they want a less-independent credit ratings agency community?  This is duplicitous and inexcusable.
4. The debt covenants that are the contractual obligation between a debt issuer (e.g. Portugal) and investors are very explicit about what constitutes an event of default.  Additionally, the various ratings agencies don’t just arbitrarily and immediately downgrade debt.  Instead, downgrades are progressive and measured.  Downgrades are also accompanied by a lot of analysis and disclosure as to what has led to a downgrade.  Lastly, downgrades are accompanied by a list of criteria, which if not adhered to, will result in further downgrades.  Portugal’s debt has been downgraded continuously for the past year.  What would constitute a further downgrade was public information!  But instead of the Portuguese doing anything about it, or the Europeans who would bail them out doing anything, they didn’t do anything.  So a downgrade should not have been a surprise!  Argh!

Just two days ago I was lauding Standard & Poors for its independence in challenging the French-led resolution to the Greek debt crisis.  Now we have a very strong and public rebuke coming from a very important political body, the European Commission.  First, kudos to the credit ratings agencies.  Second, keep your fingers crossed that the credit ratings agencies continue to defend their independence.

Me?  I become less a fan of the way the Europeans do business on a daily basis (as if it is much better here in the United States)!

Jason