Thursday, January 19, 2012

PES: European Ratings Illegitimate

European Socialists Dismiss Rating Agencies
"A dozen anonymous analysts with no shred of legitimacy and a proven track record of gross inefficiency, effectively decided on Friday to make life much harder for millions of Europeans" declaed Sergei Stanishev, president of the Party of European Socialists (PES). "This is an international scam that has to stop."

Recent events have seen ratings agencies issue downgrades to 16 of the 17 Eurozone members, including Germany and France, in addition to a downgrade of the European Financial Stability Facility (EFSF), ostensibly because last Friday's downgrade of France and Austria mean that there were now insufficient AAA-rated guarantors for the efsf to have the top-rating, risk-pooling possibilities aside.

Effects of a Ratings Downgrade
The de-facto effect of a ratings downgrade amounts to increased borrowing costs. This happens via loss of investor demand for the debt instrument in question.In fact, since institutional investors  are obliged specific risk/return characteristics to meet their fiduciary stndards and banks are obliged to specific capital requirements to counterbalance their positions just to meet the Basel rules, the process is fairly automated.

In the case of a sovereign ratings downgrade, it means that a country's government -as well as the citizens and taxpayers- face increased borrowing costs. This can make a huge difference when it comes to hard budgetary line-items such as healthcare, education, and national defense. This is the reason that the recent behavior of ratings agencies with regards to the EU and its member naionts has been an issue of such serious concern. What's worse, is that corporate debt from a country is ALWAYS rated less safe than sovereign debt, meaning that there are secondary effects in the private debt markets. 

Is it Legit?
Principly, the concern is that these higher costs are being imposed due largely to political bias on the part of the rating agencies and associated parties. In fact, during the 1990s, it emerged that right-wing Canadian sources were attempting to pressure Moody's ratings analysts to downgrade Canadian sovereign debt. This was ultimately done in order to help find a justification for the Liberal party's budget slashing agenda in 1993. 

A further point to consider, is the role of CRAs during the sub-prime mortage derivate story in the mid-2000s. At that time, rating agencies were handing out AAA ratings to issues of junk-debt. In exchange, the three main ratings agencies made massive revenues, as the issuing partie who paid the ratings agencies compensated well for free AAA ratings. Officially, it was all disguised as "consulting fees". Since this behavior came to light, leading to an explicit ban on such practices in the US in the 2009 Dodd-Frank Act, the ratings agencies have been looking for opportunities to send the message that they have stopped given away high ratings and intend for their ratings to actually be taken seriously. What better target than sovereign debt then. After all, states DO NOT pay for the services of the rating agencies, so there so is no incentive to give away ratings. 

EU Legislative Efforts
The European Parliament is currently examining proposals for more effective regulation of CRAs and the PES intends to announce a major campaign to regulate the CRA issue next week.


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