Power of Credit Rating Agencies Questioned
Following the downgrading of Greece’s credit rating to junk earlier this week, as well as the downgrading of both Spain and Portugal, with speculation that Portugal is in the firing line for a further downgrading, the call for the creation of a European credit rating firm to balance out the US dominance of this function is gaining momentum. The credit rating reductions by US rating services such as Standard & Poor’s and Moody’s Investors Service, has had a severe impact on worldwide markets, with investors selling bonds issued by the three countries, in turn driving up their borrowing costs and increasing the need for bailouts financed by the European Union. Furthermore, the Euro dropped to a 13-month low, due primarily to concerns being raised over the ability of other European countries to meet their obligations without intervention.
While EU authorities appear to be committed to creating a European credit rating firm, there are doubts that this will appease investors, who may view a government created credit rater, undertaking the task of rating the governments that created it, as less than credible. Credit rating agencies face much criticism because they have to take the tough decisions, aware that those decisions will impact on the company or country they are rating, and possibly even on world-wide markets. US credit rating agencies have taken a lot of flack for being too lenient in the past, and thereby being a contributing factor to the precipitation of the worldwide economic crisis. Now they are being criticized for being too harsh with their ratings on Greece, Spain and Portugal, although some may argue that criticisms are politically motivated.
An observation made about credit rating agencies is that they wield so much power that their decisions often become self-fulfilling prophecies. And yet the three largest US credit rating agencies – Standard & Poor’s, Moody’s and Fitch – have admitted that their ratings have been incorrect in the past, such as in spotting the magnitude of the risk regarding the US housing market debt, showing that their decisions are often based on nothing more than an educated guess.
German Chancellor Angela Merkel is among the politicians calling for a European-based credit rating agency, as is the European Union‘s financial services commissioner Michel Barnier who has been quoted as saying that ‘there are not enough rating, agencies, not enough competition, and not enough diversity’. Many agree and view it as unfortunate that matters had to reach crisis proportions before this came to light.