Dr Daniel Woker is the former Swiss Ambassador to Australia and now a Senior Lecturer at the University of St Gallen.
Following a path-breaking Australian court judgment against Standard & Poors (S&P), Stephen Grenville, in a blog post on 14 November, notes how credit rating agencies (CRAs), 'by turning dross into AAA gold', contributed to triggering the global financial crisis and thus share responsibility for the subsequent heavy losses by public sector investors. As one of the consequences, Grenville suggested that international regulators should 'require separate agencies to assess government debt, on the one hand, and private companies on the other.'
A recent study by two University of St Gallen researchers, Manfred Gärtner and Björn Griesbach, bolsters Grenville's case considerably.
Stephen directed the brunt of his criticism at the fact that the client of a CRA who pays for a company rating reaps the profit from a high grade, and concludes that CRA failings in country ratings 'seem to be honest mistakes'. But Gärtner-Griesbach, basing their findings on OECD statistics and raw material which went into country ratings by Fitch, put the main blame for the debt crisis in southern European countries squarely at the doorstep of the CRAs.
The study (Rating Agencies, Self-Fulfilling Prophecy and Multiple Equilibria? An Empirical Model of the European Sovereign Debt Crisis 2009 -2011) contends that (a) CRA ratings create an inescapable debt trap for a country once its grade dips below a critical point and (b) CRAs, following criticism of their overly optimistic company ratings before the GFC, downgraded some countries too fast and far more radically than was warranted by economic fundamentals. Country ratings thus became a self-fulfilling prophecy.
Following considerable international attention on their study, including from CRA lawyers, co-author Manfred Gärtner tells me that he and Björn Griesbach are working hard on statistics regarding the other two big CRAs (S&P and Moody's) and that he doesn't expect fundamentally different conclusions. He also said that CRAs, due to the microeconomic emphasis of their staff, might simply not be capable of doing the macroeconomic job of rating country performances.
This conclusion was reinforced by a recent S&P macroeconomic study claiming that, by sheer volume of safe bond buying (€80 billion over the first seven months of 2012), the Swiss National Bank (SNB) had kept rates for 'Bunds' artificially low. It now turns out that S&P had exaggerated by a factor of three or four the net volume of the SNB's bond buying.
So, if not the CRAs, who should rate countries? It can't be a purely intergovernmental agency, as systemic public sector bias could then be claimed. It will have to be a common effort by representatives of the public and the private sector, possibly in the form of a public law foundation. CRAs would be well advised to participate constructively in such common efforts. They probably will; first reports are just in that an Italian prosecutor, following a complaint, has started to look into Italian CRA ratings and possible cause for damages following unprofessional work by the agencies.
So CRAs are perhaps being pressured to do what they were supposed to do but didn't: provide impartial and fully professional ratings. There is a clear parallel here with what happened in the banking sector: 'the market' is good as a base, but needs constant oversight and occasionally radical corrections from public sector regulators.
Photo by Flickr user woodleywonderworks.