Wednesday, 5 July 2017

The Continued Presence of Credit Rating Agencies on the Global Stage

In today’s post the focus will be on the effect of credit rating agencies in relation to national interests. A recent spate of news articles confirms that rating agencies, with respect to their output, have a demonstrable effect upon the health of a nation state’s future, in spite of analysis that suggests the actual value of their output is limited at best. In 1996, the New York Times Pulitzer-winning Journalist Thomas L. Friedman commented, now famously, that ‘you could almost say that we live again in a two-superpower world. There is the U.S. and there is Moody’s. The U.S. can destroy a country by levelling it with bombs; Moody’s can destroy a country by downgrading its bonds’. Whilst many have debated this notion – Professor Frank Partnoy provides a representative example of this – it is worth instead looking at the reality of the situation, rather than the theoretical landscape. To do this, there are a number of clear examples that show, rather counterintuitively, that the rating agencies have continued to develop and act upon their influence in the aftermath of the Financial Crisis, not the opposite. The understanding of this shows, quite clearly as contested here, that regulation of the industry needs to be more invasive a decade on from the Crisis, not less.

The most obvious example of the agencies’ power, and by ‘agencies’ we are only referring to Standard & Poor’s and Moody’s (given their dominance), was witnessed with the recent downgrading of China’s Sovereign debt. On the 22nd of May this year, it was noted in the financial press that China had promised to allow U.S. credit rating agencies into its domestic market to help draw on foreign investment, with the underlying aim being to provide confidence where Chinese rating agencies could not. Two days later, Moody’s cut China’s sovereign debt rating from Aa3 to A1 for the first time since 1989, stating in the process that ‘China’s financial strength will erode somewhat over the coming years’ which led, not unexpectedly, to Chinese officials accusing Moody’s of exaggerating China’s economic difficulties and underestimating financial reforms. Whilst columnists will see this move as an indicator to other issues, the issue for us is the extraordinary power that the agencies hold over entire societies; though China is unlikely to collapse because of this downgrade, the effects are more than statistical – the downgrade initiates a chain reaction of bad press, rating-based reforms which may not necessarily be what a given country needs, and ultimately the accumulation of negativity that can quite easily cause a spiral. With China’s economic position on the global scene, any spiral could have dramatic effects for almost all corners of the globe. However, the agencies do not just reprimand, they also suppress, and two countries in particular are feeling that pressure at the time of writing.

Although, essentially, it is the same story but of differing degrees, we shall start with the current situation in Portugal. The Portuguese have endeavoured to develop an anti-austerity pathway to recovery which, confirmed by the E.U. at the end of May, has now seen the country move out of the E.U.’s ‘corrective’ element of its ‘stability and growth pact rules’. Yet, this positive news for the Portuguese people did not make an impact upon their nation’s credit rating, which forced the President, Marcelo Rebelo de Sousa, and Prime Minister, to condemn the actions of the agencies, suggesting that they were preventing Portugal from recovering without merit – Portugal’s credit rating remains at ‘junk’. However, Portugal is not the only country being restrained by the agencies, with India currently embattled against the agencies – India was unsuccessful in its attempts to have its rating upgraded in 2016, and have been questioning the agencies’ methodologies ever since. With a leading Indian minister declaring that the agencies’ assessment was ‘one of the most egregious examples of compromised analysis’, the tone has been set for relations between the country and the leading agencies, which brings all of the BRICS nations into direct conflict with the agencies as this author has discussed elsewhere. There seems to be a stalemate at play that fundamentally confirms Freidman’s observation.

Ultimately, the agencies responded to attempts via the Dodd-Frank Act of 2010 to intervene in their methodologies extremely negatively, and have fought the intervention ever since. Subsequent regulatory endeavours have wilted under such a staunchly-defended approach and rather quickly the rhetoric surrounding rating agency methodology has turned to the need to increase transparency, rather than intervening and enforcing x, y, or z. The issue with this is two-fold. Firstly, the top rating agencies have proven, without question, that they cannot be trusted to perform within the confines of the law – multiple indictments since the Crisis confirm this; the agencies were not just ‘caught up’ in the hubris of the era. Secondly, the protection attached to the agencies’ processes and constitutionally protected ‘freedoms’ (this is a notion that is being contested back and forth post-Crisis) is, in reality, the residue of the framework that surrounded the very earliest commercialised agencies in the 1840s – no longer is it necessary that the products of the agencies, and the processes that underlay them, are protected at all costs. The mercantile environment of the 19th Century has given way to the actuality of the agencies no longer being important to a bourgeoning trade but, now, society. It is important, in fact it is vital, that the methodologies of the agencies are controlled more than they currently are, because the actions of agencies that once informed distant mercantile creditors on the creditworthiness of borrowers are now systematically affecting societal development on an almost daily basis, and their influence continues to grow despite continually transgressing – where that equation takes us all is a frightening contemplation.

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