Rating agencies as powerful as ever
Some people assumed that after the debacle over the 2008 mortgage-backed security crisis in the U.S., the credit rating agencies would be discredited. However, here we are three years later and the focus is still on the same rating agencies, waiting with bated breath to see whether they move the ratings of some of the world’s most important economies.
Within the last six months rating agencies have played a big part in shaping the direction of financial markets. First, there was Standard & Poor’s downgrading of the U.S. at the start of August, which caused a wave of risk aversion and turmoil on financial markets. Europe has also been the focus of concern.
Italy has seen its credit rating slashed to the lowest A rating you can have, while new kid on the block rating agency Egan Jones has gone one step further and on Monday cut Italy’s rating to BB from BB+. Belgium has also been cut and rumours are spreading that France isn’t going to keep its coveted triple A status for much longer.
Far from drift into the background, the focus has been on the diminishing number of countries rated triple A in the western world and what this means for borrowing costs. France has also been under the rating agencies’ microscope. It is at risk of losing its triple A credit rating due to its high public sector debt level combined with a sizeable deficit, also Paris has been slow to take steps to try and bring public sector finances under control. A false statement that France had been downgraded by Standard & Poor’s in October caused French bond yields to surge and it also enraged the French government who threatened to take steps to ban the rating agencies from commenting on France again.
But in recent months there has been no smoke without fire and newspaper reports this week suggest that S&P is days away from stripping France of its top rating due to the slowdown in global growth and the impact this will have on French tax receipts. This couldn’t come at a worse time for Europe as France is integral to the European Financial Stability Facility (EFSF) – Europe’s rescue fund, which relies on France and Germany’s triple A status to keep its own top rating. Thus if France is stripped of its triple A this will have ripple effects on the EFSF fund and could make bailing out Europe’s troubled members more expensive, thus aggravating the debt crisis even more.
There were rumours that France was meant to be downgraded last week along with Belgium; however this was scrapped at the last minute. This has set the market rumour mill into over-drive with speculation building that the EU high command could have had something to do with the delay.
Politics and the credit rating agencies have been more intertwined since the start of the sovereign debt crisis in early 2010. In the UK the Chancellor of the Exchequer waxes lyrical about how important the UK’s triple A rating is to keep public borrowing costs low. In fact, during his autumn statement to Parliament this week, the Chancellor tried to shift the tone of the debate on UK fiscal consolidation towards the impact of lower borrowing costs on household finances, rather than focusing on public sector spending cuts. Thus, if the UK wants to continue to borrow cheaply it will need to avoid a downgrade from the rating agencies, giving them pivotal roles in the government’s austerity plans.
Although Europe is the focus, the U.S. is also on the rating agencies’ radars. Just this week Fitch said that the U.S. could be downgraded by 2013 if it doesn’t stick to its debt reduction plan. It is concerned that bickering and partisanship on Capitol Hill will cause the deficit targets to slip, which should be taken seriously by Washington as the U.S. is the world’s largest debtor with $14 trillion of debt outstanding.
So, as much as credit rating agencies were vilified during the peak of the financial crisis they are as powerful as ever. During sovereign crises investors rely on their analysis and opinions to determine which countries are credit worthy and which are not. The problem is that the pool of countries with strong credit ratings is getting smaller so that triple A status is now more coveted than ever.
Image — A member of the association ‘Sauvons les Riches’ (Save the Rich) installs placards outside the office of credit rating agency Moody’s Investor Services in Paris October 24, 2011. REUTERS/Philippe Wojazer