The Unchallenged Power of the Rating Agencies

In this bleak economic era, the only constants that have prevailed throughout the most part of the global financial crisis are risk and uncertainty. On January 12th, Standard and Poor’s downgraded France, joint-chief compere of the Eurozone’s economic horror show and its second largest economy. The very same day, the economies of Spain, Italy, Portugal and numerous other members of the Eurozone suffered a similar fate. More recently, Moody’s changed the UK’s outlook from “stable” to “negative”, prompting Chancellor of the Exchequer, George Osborne, to reaffirm the state’s commitment to regressive austerity measures.

In the current state of affairs, it is beyond doubt that the ratings agencies wield an astronomical level of power over governments, often cajoling them into implementing profoundly unpopular austerity measures under the looming threat of a downgrade. Yet, their status as the arbiters of the global economy is rarely put into question.

It bears repeating that the role of these agencies is the secret to their power – they provide a sense of order and clarity to a world rife with uncertainty, providing impartial estimations of financial strength and creditworthiness for would-be investors.

At face value, this arrangement seems both logical and desirable. At a deeper level however, the ratings agencies can act capriciously, precipitating the disorder they are supposed to counterbalance. Defendants would claim that the agencies solely serve as a messenger, not in any sense a contributor to all the mayhem that characterizes the contemporary financial system. To counter, I would draw attention back to the original source of the current economic misery, the sub-prime mortgage crisis, wherein many securities rated highly by the credit rating agencies were swiftly and vastly devalued at the onset of the crisis, misleading countless investors and contributing heavily to the downward spiral that eventually mutated into the global depression.

Thus, rather than mitigate uncertainty, ratings agencies amplify it. They fan the flames of speculation, impacting business confidence as decision makers sit on capital rather than risk losing it. What’s more is that while risk and uncertainty propagate, the demand for the ratings agencies to provide order also mounts, entrapping the economy into a positive feedback mechanism of unpredictability.

Over-reliance on the rating agencies follows, and that’s exactly the situation we’re currently in. Worst still, the duopoly of the rating agency market, with both S&P’s and Moody’s appropriating roughly 80% market share between them, raises further concerns. In particular, in the absence of competition, transparency issues and flaws in the actual ratings themselves are pervasive. The sub-prime mortgage blunder aside, the ratings agencies’ inability to predict crises (the Asian financial crisis, Enron’s bankruptcy and deteriorations in both AIG’s and Lehman’s creditworthiness, to name a few) has invited significant criticism.

Yet, there remains no alternative to replace the ratings agencies. As uncertainty becomes more of a definitive tool for understanding the international economy, rating agencies will only gather more influence. They also cannot be silenced, since ratings are mere opinions that are protected by free-speech laws. One option would be to reverse the outsourcing of risk judgment from governments to ratings agencies; it seems improvident to place the fate of whole currency zones at the whims of two or three private firms whose past record of judgment is hardly unblemished.

However, nationalizing the role of ratings agencies would open a can of worms that is simply incompatible with the neoliberal model of Western capitalism, rendering this option wholly unfeasible. One glimmer of hope lies in increasing competitiveness. This would ideally rectify transparency issues, while ensuring a certain level of prudence and diligence in the formulation of ratings. It could however, lead to a situation wherein cherry-picking prevails, incentivising agencies to give irresponsibly high ratings. Overall though, there are no substantive or substantial signs that the ratings duopoly is to face more competition anytime soon and governments continue to act upon the vicissitudes of Moody’s and S&P’s. As such, the global economy is sure to feel the squeeze as overawing uncertainty tightens its grip. For this commentator, the dreary situation calls for a downgrade of my own – from “outlook: negative” to “outlook: bleak”.