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Why You Still Can't Trust Rating Agencies

Credit-rating agencies were among the bogeymen of the global financial crisis, and for good reason. Moody's, Standard and Poor's, Fitch, and others failed to appraise the real risks of billions of dollars in securities that eventually went bad.  Now, they're trying to act responsible by jumping on the fiscal woes of government borrowers. We still shouldn't trust them.

In the corporate world, there are at least three things wrong with credit-rating agencies.  First, they get paid by the very companies whose securities they rate.  Second, because they can't offer the big bonuses and profits of banks and hedge funds, the agencies don't necessarily have the brightest financial minds on their staff; the people who devise the securities being rated are probably cleverer.  Third, only the opinions of the three major rating agencies seem to matter, and they often engage in a kind of tit-for-tat competition when they should just be focusing on the fundamentals of the securities they're rating.

Rating government bonds isn't necessarily as lucrative for the agencies, but it does give them more clout in the markets.  They've been trying to reassert their relevance by using that clout ever since the global financial crisis began.  Notably, there was last year's downgrade of the United States by Standard and Poor's, complete with a huge mathematical error. Then there were downgrades for European countries, culminating in this week's flurry from Standard and Poor's again.

Some of these downgrades have been puzzling.  For example, Standard and Poor's just lowered Italy's rating (and the ratings of three other countries) by two notches.  The agency's previous downgrade of Italy had occurred in September 2011.  So, was there no reason to make an intermediate move and downgrade Italy by one notch in the intervening four months?  Did the raters just not get around to looking at Italy until now?

It wouldn't be too surprising, given Moody's response to the move by Standard and Poor's. Showing its best competitive spirit, the agency said that it would not be looking at France again until the end of the quarter.  That's more than two months away; does Moody's really think nothing will happen to affect France's credit-worthiness between now and then?  Perhaps - until September, Standard and Poor's main rating of Italy hadn't changed since 2006.

The ratings are filled with puzzling comparisons, too.  Standard and Poor's rating for France, a country harnessed to the euro as if its life depended on it, is now the same as its rating of the United States.Yields on the French government's bonds are about 50 percent higher than those on the Treasury's notes.  Are the markets so wrong, and the ratings agencies so right?

It just doesn't add up.  Yet the media still make much of all the downgrades, even though the moves usually don't change anything in the actual fiscal situations of the countries involved.  It's laziness, really - the news stories practically write themselves from the rating agencies'press releases.  But the media are just playing into the rating agencies' hands, helping a bunch of dinosaurs to maintain some semblance of importance when they should have been fossils long ago.

 

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