When the housing market crumbled, the agencies — Moody’s, Standard Poor’s and Fitch — came across as incompetent, conflict-ridden and craven. They had handed out Triple-A ratings as if they were party favors, based on mathematical models that turned out to be absurdly overoptimistic. They did not do the work to notice that many securities were stuffed with mortgages of far lesser quality than advertised. They were paid for the ratings by those who created the bad securities.
Now the agencies are under attack again, but this time they look noble. If European politicians have their way, the new image could be one of persecuted truth-tellers.
Moody’s has recently led the way in cutting the ratings of European countries to junk status. It followed S. P. in cutting Greece’s rating, but has led in recent days in cutting first Portugal’s and then Ireland’s. It pointed to the fact that Greece might be allowed to default as a reason to worry about other countries.
A reasonable political reaction would be to say that the negative opinions would be proved wrong, and then to take the actions needed to avoid defaults. Unfortunately, Europe has no real idea how to accomplish that.
Instead, Europe has chosen the strategy laid out 90 years ago in a novel by Ring Lardner, in which a father had a ready answer for an unwanted question:
“ ‘Shut up,’ he explained.”
“We should ask ourselves,” said Michel Barnier, the European commissioner whose bailiwick includes financial markets, in a speech this week, “whether it is appropriate to allow sovereign ratings on countries which are subject to an internationally agreed program.”
Coming from the man with primary responsibility for policy decisions on rating agencies in Europe, that sounds very much like a threat.
He was echoing a suggestion voiced in March by Christine Lagarde, then the French finance minister, after Moody’s downgraded Greek government bonds, already rated below investment grade, to a lower class of junk.
“I am personally convinced,” she told an interviewer, “that credit ratings agencies should not intervene and should not grade countries which are working with the European Commission, the International Monetary Fund and the E.C.B.,” the European Central Bank. Ms. Lagarde now runs the I.M.F.
The Moody’s report that so alarmed Ms. Lagarde said, “There is some possibility that private creditors would be expected to bear some losses” in Greek bonds. Now it turns out that the I.M.F. thinks Moody’s was right, according to a staff report issued Wednesday.
Over all, the rating agencies have done a decent job on sovereign debt. “All sovereigns that defaulted since 1975 had noninvestment-grade ratings one year ahead of their default,” the I.M.F. reported last year.
The power of the rating agencies grew in recent decades because government regulators often found it easier to incorporate the ratings in other rules. Worried about the credit quality of securities owned by money market funds? Require those securities to have high ratings. Trying to decide how much capital banks need to offset the risk of differing loans? Tie credit rules to ratings.
Now there is general agreement that regulators should stop requiring the use of ratings, and thereby remove any official imprimatur from the agencies. But that is running into resistance from bank regulators and banks, particularly smaller ones, in both Europe and the United States. They don’t want to have to do their own credit research, and say that in some cases it would be too complicated.
In the past, it has not just been perceptions of expertise that caused the agencies’ opinions to seem important. The agencies sometimes were allowed access to confidential corporate information, a practice that should be banned. If they can know something, so should anyone else interested in the security.
There is a certain chicken-and-egg question that politicians might consider. Are Europe’s finances a mess because the rating agencies spoke up, or did they speak up because the finances are in disarray? That answer is obvious.
Greece’s prime minister, George Papandreou, rightly said this week that European leaders were guilty of “taking decisions that in the end prove too little, too late, to convince markets.” Of course, Greece’s own inability to collect taxes and control its budget deficit has more than a little to do with the failure to convince markets.
What seems to anger Mr. Barnier the most is that the agencies are messing in areas where international judgment has already been applied. “These states are under international programs,” he told me this week. “These efforts may be jeopardized by ratings coming out of nowhere.” He added, “The problem is one of democracy.” Europe already requires that countries get 12 hours advance notice of any reports, to give them time to argue that facts are incorrect. (Is it conceivable that some finance ministry has used the time to tip off favored traders about what is coming? Yes.) The European Union is considering lengthening that period to three days. It also has discussed finding ways to punish agencies for “incorrect ratings.”
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