Credit ratings agency scrutiny by the EU

Yesterday the European Commission announced the creation of the European Securities and Markets Authority (ESMA).  The Authority will be charged with both the regulation of, and monitoring of, credit ratings agencies.  As stated now ESMA would come into being next year.  The creation of this new European regulatory agency comes in the midst of a firestorm of criticism of the major credit ratings agencies, Moody’s, Standard & Poors, and Fitch, which are all U.S. businesses.  The thinking by Europe is that these U.S. institutions and their credit downgrades of the sovereign debt of EU members has precipitated the continent-wide financial crisis.

I think this is a bunch of bull.  While I feel that the credit ratings agencies do issue biased ratings, often do not anticipate credit problems of debt issuers, and are slow to respond to economic changes, I also feel that more independence would aid them.  I also feel that what has precipitated the European financial crisis is profligate debt spending by EU member nations that can’t adhere to their self-imposed budgets except through lying.  Not only that, but the EU’s economic policies, including lots of entitlement-based institutions, have led to an entire continent of nations unable to compete in an unforgiving capitalist environment.  So basically the EU’s creation of ESMA is a variation on a popular European theme: When in doubt, blame the United States.

I do feel, however, that in the short run additional scrutiny of the major credit ratings agencies is a good thing.  Why?  It will hopefully provide the inducement to get them to become better and more reliable at what they do.  In particular, the agencies should begin to address the three issues I outlined above.  In my opinion, lax U.S. regulation of financial markets and of credit ratings agencies are primary causes of the 2008 and 2009 recession.  So that the credit ratings agencies are accountable not only to U.S., but also European, regulators is a fantastic thing.  This is possible because the U.S. ratings agencies operate in Europe, therefore fall under European jurisdiction.  It remains to be seen if the ESMA is just a bit of politically expedient rhetoric meant to placate a disgruntled, U.S.-bashing, European public.  Teeth need to follow up the bark.

In the long-run, Europe needs more than rhetoric to fix its fundamental structural economic problems, and ESMA is, in my opinion, not a part of that solution.

Jason