Ratings agencies are not the villainous enemies

Prof Philip Booth writes for Public Service Europe

The only thing worse for a government than a downgrading of its debt is not knowing whether it should be downgraded because the main players are banned from offering opinions

When asked to comment, this morning, on the proposal by European Commissioner Michel Barnier to ban ratings agencies from issuing downgrades of government debt in certain circumstances, I stalled – putting it in the "early April fool" file. After completing some other tasks first, I was then staggered to see that the proposal was actually made by the commissioner in a speech. This would be a profound move to prevent freedom of speech. 

It is true that ratings agencies have been raised upon a pedestal by the use of their ratings for regulatory purposes - therefore, grossly distorting the market. For example, the use of ratings of bonds to set bank capital gave agencies an incentive to over-rate bonds – the possibility of reducing the regulatory capital of a bank by providing a good rating, perhaps, distorted their incentives. Also, their use in the United States for regulatory purposes, combined with the effective creation by the regulators of an oligopoly, has removed competition from the market. As it happens, Barnier suggested in the same speech that he was going to address some of these problems. 

Fundamentally, though, a rating agency simply provides an opinion on the credit worthiness of the issuer of bonds. In the case highlighted by Barnier, the relevant issuers are sovereign governments. We already have the ludicrous situation whereby banks are encouraged to lend to over-stretched sovereign borrowers because the regulatory capital requirements from holding such bonds are less than those from holding similar private sector risks. We are now being told that some of the most important and knowledgeable institutions in the debt markets will not be able to comment, if they believe a particular sovereign issuer has become more risky. 

Read the rest of the article on the PublicServiceEurope website.

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