European pressure to break the stranglehold of the big three credit rating agencies intensified yesterday, as the head of the European Central Bank slammed them as an "oligopoly" and the Prime Minister of Luxembourg called for a new independent body to assess the creditworthiness of European government debt.
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Politicians and officials have been enraged by rating agency decisions in the past week that have complicated their efforts to bail out weaker eurozone members and caused further turmoil on the debt markets.
The controversy has shone a spotlight as never before on the operations of the big three agencies – Standard & Poor's, Moody's Investors Service and their smaller rival Fitch – but economists and analysts say it is easier to rage against their power than it will be to curtail it.
Jean-Claude Trichet, the president of the ECB, said the effect of having such powerful rating agencies, whose downgrades of a country's debt can force existing bondholders to sell, was to exacerbate financial crises.
Jean-Claude Juncker, the Prime Minister of Luxembourg and chairman of the eurozone committee of finance ministers, said the agencies' influence had been "disastrous" and called for the setting up of a new, European rival. "I'm really of the opinion that we should intensify our efforts to create a European rating agency in order to be able to better judge the medium-term outlook for the European states," he said.
On Tuesday, Moody's became the first agency to strip Portuguese government debt of "investment grade" status, cutting its rating to junk and saying it did not believe the existing bailout package would be enough to restore stability to Portugal's finances. A day earlier, Standard & Poor's said the proposed structure of a new rescue for Greece would effectively impose losses on holders of Greek debt and would therefore constitute a default – something that would trigger unknown consequences throughout the debt markets.
The big three rating agencies have acquired their power over decades, and it has become semi-institutionalised by government regulations around the world which are meant to protect investors. Financial firms which invest the public's pension or insurance contributions are required to use the agencies' ratings to ensure their investments are no riskier than agreed. Banks are also required to hold a certain amount of highly rated government bonds to satisfy regulators that they can withstand a financial crisis.
That is why the decisions of the small band of credit analysts who decide a country's credit rating have immediate real-world consequences.
The three companies typically downplay the influence of any particular analyst, saying that decisions on a government's creditworthiness are taken according to well-publicised and long-established rules, based on projections of future tax income and spending, often debated in face-to-face meetings with ministers, civil servants and central bank officials. All decisions are ratified by internal committees.
Nonetheless, governments, particularly those in a tight fiscal position, can vigorously disagree with the assumptions being made. Earlier this week, Italy's securities market regulator Consob summoned a representative of Standard & Poor's to explain why the agency had warned it was considering downgrading the country's debt. Italian politicians had complained that S&P came to a negative conclusion about the country's planned austerity programme, even before details of the package were finalised.
From triple-A to junk
Like a conscientious pupil waiting for grades from the teacher, every government wants straight As from the credit rating agencies. A rating is simply a measure of how likely it is that an investor who lends money to a government (by buying its bonds) will get their money back and the interest they were promised. At the top end of the scale, AAA, or triple-A, means there is practically no chance of a default.
Standard & Poor's, Moody's, Fitch and a handful of smaller rivals all calculate probabilities to place bonds on a sliding scale that heads down through A- and BBB+ to B-. Below a certain cut off point in the Bs, bonds become "junk" – off limits to all but the most speculative investors.
As with anything that involves prediction, ratings are kept under constant review and change as new facts come in, either about the strength of a country's economy and therefore tax receipts, or about government spending plans.
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