Tijo Salverda

News and Thoughts

Rating confusion

Greece, again downgraded. Portugal, junk status. Ireland, Baa3. Many are fearing what else there is to come from the offices of Moody’s, Standard & Poor’s and Fitch. If we would have a European rating agency it would be different, so the argument goes. Would it be really? If using similar tools, a European one would probably come to the same analysis. It would not be particular objective if they would be less critical about these European economies just because they’re European. After all, much of the mess comes from analysts who were far too positive about the state of these economies in the past – and, yes, this includes the credit rating agencies. Lending them cheap money.

In that sense, the present discussion is a dead end. Because the problem doesn’t seem to be with the rating agencies necessarily. It’s the financial community, governments and the like relying too much on them – they can’t think for themselves anymore, or they have made their business and regulatory models too dependent on the ratings. But the ratings are just a tool for measuring risk. They might be right, they might be wrong. But they’re based on the same public information available to people willing to do their own analysis. That, to me, seems to be the issue. Based on their own risk analysis, the financial sector and others involved can set their own terms for lending money to Greece cum suis. Some insightful analysts have already written about the spiral trap of downgrading bonds: Greece, Portugal, etc. have to pay higher interest rates, increasing the chance of a default, leading subsequently to another downgrade. Chances seem more likely you’ll get your money back when you demand lower interest rates from, for example, Greece, even though ratings would correspond with higher ones.

A roll over, then, would matter less as well. Just ignore the rating agencies that argue a ‘roll over’ equals a default. Investors should be able to assess for themselves whether they think a (French) bank is worthy lending money to – and at what rate.

The debate should not so much be about replacing the credit rating agencies, or about the agencies being to strict, but as Alexandra Ouroussoff shows in her Wall Street at War, though talking about the agencies vis-a-vis the corporate world, it should be about the underlying assumptions. We should question the agencies’ inherent (bordering on the unquestionable) belief that we can measure risk and uncertainty. Of course, in order to know whether the borrower repays you a certain level of looking into the future is required. But this should include much more awareness about the impossibility to be really able to measure all risk involved. One thing, after all, that has once again become evident the last couple of years, is that the future is difficult to predict, let alone calculate.


Update (16 January 2012): obviously, the value of investments, such as government bonds, institutional investors have on their books depends on the (legally binding) ratings of the credit rating agencies. It should be discussed whether this (self-)inflicted dependency on ratings is sensible, yet that is behind my point here. I am puzzled about which rating is decisive? Standard and Poor’s downgrading of France has sparked fear about the consequences of revalueing investments in (French) sovereign debt – and potentially France’s borrowing costs. Fitch and Moody’s, however, recently kept France’s AAA status. Which rating of the big three is conclusive for the value of investments? The lowest? A combination? Or?