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Integrity of ratings agencies questioned

The three major rating agencies S&P, Moody's and Fitch influence 90% of the market Keystone

Debt-laden European countries have been given a rough ride and pushed further into trouble by the questionable actions of ratings agencies, according to a study on how sovereign credit worthiness is calculated.

This content was published on July 30, 2012 - 15:05
swissinfo.ch

Researchers at St Gallen University believe that the big three agencies have at best made mistakes in rating countries such as Greece and Spain, and in the worst case scenario systematically and deliberately manipulated the markets.

The report released last week concludes that there is no rational statistical basis behind the sudden and extreme downgrading of several European countries since the 2008 financial crisis.

The big three United States agencies - Moody’s, Fitch and Standard & Poors – have used different formula to rate these indebted states to that used by other countries outside of Europe, study co-author Manfred Gärtner told swissinfo.ch.

“These ratings cannot be explained by any of the variables we used in our calculations so there has to be a suspicion that the agencies switched to a different model for some countries,” he said.

“We have to ask the question: is it reasonable for such big mistakes, that are way off past ratings patterns, to have happened unintentionally? If the answer is no then there has to be some purpose behind these ratings.”

Downgrades “too severe”

The St Gallen University study compared the ratings agencies’ treatment of debt-troubled European countries and that of several other states worldwide.

Even taking into account deteriorating global financial and economic conditions, the researchers found no justifiable reason for downgrading Portugal by eight notches and Ireland by seven between 2009 and 2011.

The ratings agencies have become used to criticism and conspiracy theories ever since the financial crisis struck. They were at first condemned for awarding worthless financial derivatives gold plated ratings whilst being paid by banks to carry out the analysis.

Now they have come under attack for the severity of their downgrades of countries and their ability to pay off debt.

All three agencies have consistently denied being influenced by political or commercial interests, and while acknowledging that past mistakes were made in rating derivatives, have staunchly defended their current methods of rating countries.

Criticism rejected

Reacting to the St Gallen report, Moody’s said that its ratings had proved more reliable than other financial market indicators.

“[We] have a strong track record as predictors of default, reflecting the credit realities of a particular issuer,” Moody’s told swissinfo.ch in a statement. “We apply our sovereign methodology [rating of countries] globally and consistently.”

Moody’s also rejected the “self-fulfilling” charge that downgrades generate impetus for continued problems by creating a vicious circle of scaring away investors, hiking interest rates on debt repayment and thus forcing further downgrades.

“Sovereign ratings have not contributed to the crisis: the structural and economic issues that are its ultimate cause are well documented,” Moody’s added.

Stick to markets

Such sentiments are unlikely to put off many critics, particularly the European Union that is toying with the ideas of tightening regulation of agencies, banning some of their comments on debt-troubled countries and of creating a new European agency to counter the influence of the US-based trio.

EU suspicion of US institutions has burned bright ever since the financial meltdown and has been given further impetus by an ongoing war of words between the two continents on who is to blame for the current global economic impasse.

“It is very interesting that whenever the economic situation in the US worsens, the ratings agencies throw the spotlight on Europe,” EU Justice Commissioner Viviane Reding said last week.

Banks and other financial institutions have also come to dislike the ratings agencies’ most recent verdicts. Last month, Credit Suisse was downgraded three notches by Moody’s and UBS by taken down by two pegs, alongside a raft of other downgrades of different banks.

The Financial Times recently reported that a group of banks had got together to discuss ways of diluting the influence of ratings agencies. Neither Swiss bank responded to questions about the newspaper article.

While most observers feel that banks should be left to defend themselves against ratings agencies, many also feel that countries should not be subject to the same scrutiny.

“Ratings agencies have some important functions in the financial markets,” Manfred Gärtner told swissinfo.ch. “But they should either be forced out of sovereign ratings or made to be more cautious – by finding a way for countries to take legal action against them if necessary.”

Ratings agencies

The three principal ratings agencies in the world are Standard & Poor’s, Moody’s and Fitch, all of which are privately owned.

Their role, in theory, is to independently evaluate the risk of bankruptcy or non-reimbursement of financial players who issue debt bonds.

In effect, they inform investors of the risks they take if they loan to such a company or country. 

They lower their ratings based on the opinion of their analysts who look at compatible criteria, management, risk, company outlook, economic vigor, institutional stability, monetary and budgetary policy.

For both companies and countries, a downgraded rating translates into a higher rate of interest meaning that borrowing money becomes more expensive.

Following the Enron scandal and the sub-prime crisis, the ratings agencies were accused of reacting too late for having maintained their ratings for too long.

Paid by the companies that want to be rated, suspicions have been aroused that the agencies could have attributed better notes than actually deserved in order to maintain a contract in the face of competition from the other two agencies.

However, all three agencies have strenuously denied this practice and no allegation has been proven.

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