Monday, August 5, 2013

We need an independent rating agency

It's urgent to reform the current rating system with an independent agency to ensure more transparency and objectivity in the functioning of financial markets. But some still think that the existing system is a "necessary evil" in the absence of a better one.

The issue is that there is a gigantic conflict of interest. Like any private business, the rating agencies are traded in Wall Street; Moody's has Warren Buffett (the American richest man) as main shareholder and S&P is part of a diversified  conglomerate like McGraw Hill. We assume that they orient their judgments according to their investment needs or their client interests. The worrying thing is that they are accountable to their shareholders , not to the general public.

Their credibility was put in question when they just ignored the subprime bubble or gave a favourable rating to Lehman Brothers just before it was forcedinto bankruptcy in September 2008. In fact, they have a direct responsibility in the financial crisis, by giving wrong signals to the market and downgrading sovereign debts, without being totally objective in their assessments . The US government has denounced S&P for 5 billion $ after it downgraded the US debt in 2011. In Europe, several countries have been downgraded or bailed out with their debt rating being close to junk bonds and a higher probability of default in coming years. When  S&P downgraded the Italian debt to triple "B", the Italian Finance minister contested the logic of the US agency on the grounds that the   'unsolicited' rating helped the agency to increase its own influence and  financial gains.  

All this reinforces the conviction that we need a 'popular' agency, a body where the shareholders are the citizens and where the financial analysts are just civil servants, like the FED or SEC. This idea will, however meet strong political resistance. There are other options which are being explored, such as a system run by supranational bodies such as the OECD, the BIS (Bank of International Settlements) or the IMF (which is a lender of last resort for developing countries and therefore exposed to conflicts).

This issue will be on the agenda of the forthcoming G-20 summit in St Petersburg. Unsurprisingly, the proposal will be put forward by Italy - which leads the club of the 'southern periphery', the most affected area by the financial crisis. The rationale is to free these countries from the 'diktat' of financial markets and avoid in the short term a potential collapse of the eurozone system, with further defaults in Italy and Spain. This calls for more structural measures, such as a strong and rapidly operational Banking Union along with appropriate governance mechanisms. What is now certain is that we cannot leave the delicate task of rating the sovereign debt of the eurozone in the hands of private interests.

1 comment:

  1. The US Department of Justice and the SEC (Securities and Exchange Commission) have launched a legal claim against Bank of America, the US second largest bank, over fraudulent mortgage securities on investors. Rating agencies were silent on this episode as they were for Lehman Brothers.