"The NHS will last as long as there are folk left with the faith to fight for it"
Aneurin Bevan

Sunday, 2 May 2010

The Corrupt Ratings Agencies

I have written about George Osborne's ludicrous "New Economic Model" before, but I want to return back to one of his "benchmarks" and discuss it in light of a new article by Nobel Laureate Paul Krugman.

Osborne's first "benchmark" was to "ensure macroeconomic stability". Osborne said:

"We will safeguard Britain's credit rating with a credible plan to eliminate a large part of the structural deficit over a Parliament."

As I pointed out in my earlier post, the credit rating agencies are self appointed, there is no accreditation other than they have customers who pay for their services. Osborne seems to think that it is important to structure our economy according to what these self-appointed people think, and not according to what is best for the country. 

But let's have a look at what Krugman has to say about them. Commenting on their behaviour during the sub-prime crisis he says:

"of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status."

So clearly the ratings agencies got the sub-prime market totally wrong. This is important because it was the sub-prime market that caused the financial crisis, so the one area where the rating agencies could have saved their clients billions of dollars (and taxpayers too) they were totally wrong Was this incompetence? Well, no, as Krugman explains, it was corruption, yet Osborne is betting our economy on them.

Krugman is extremely damning of these agencies:

"The rating agencies began as market researchers, selling assessments of corporate debt to people considering whether to buy that debt. Eventually, however, they morphed into something quite different: companies that were hired by the people selling debt to give that debt a seal of approval. "

Can you trust people who are supposed to give you advice but are actually recommending something that they are paid to push? Krugman further highlights the corruption of the rating companies:

"The Senate subcommittee has focused its investigations on the two biggest credit rating agencies, Moody’s and Standard & Poor’s; what it has found confirms our worst suspicions. In one e-mail message, an S.& P. employee explains that a meeting is necessary to “discuss adjusting criteria” for assessing housing-backed securities “because of the ongoing threat of losing deals.” Another message complains of having to use resources “to massage the sub-prime and alt-A numbers to preserve market share.” Clearly, the rating agencies skewed their assessments to please their clients."

Frankly this is saying that in future when you see a pronouncement by S&P or Moody's you cannot regard it as being an unbiased, expert decision based on the actual value of the product, but instead as being what they have been paid to say about the product. They are simply salesmen of someone else's products, without actually mentioning who is paying them. So the pronouncements of such agencies on UK debt will have more to do with the benefits of skewing the market to the advantage of their real client (someone intending to make a profit from UK gilts) than on the actual value of those gilts. Should we trust our economy to such people?

According to Krugman the current senate bill will have little effect on this corruption. Krugman gives another option (from Matthew Richardson) where there will be a level of accreditation in that the Securities and Exchange Commission determines which rating agencies are allowed to rate bonds. However, Krugman  comments that although this is something, it will not completely solve the issue. 

However, what is clear is that the rating agencies have too much power already and it is simply reckless to base government economic decisions on rating agencies. But that is what Osborne says he will do.

1 comment:

  1. Except you forget that rating agencies are a backward looking indicator....the market re-values the risk of a product and only then will a rating agency make a change.

    For example, Greece is currently just above junk status, but the market trades the bonds as if they are well below junk ratings. The ratings agencies might all cut the Greece ratings, but it won't affect the market - the damage has already been done (by the Greek government).