The world’s three major private credit-rating agencies (CRA) Standard & Poor’s, Moody’s and Fitch are using their power to prevent low-income countries from restructuring their debts and stimulating their economies. Credit rating agencies realise that developing economies who engage with private creditors, which is part of the G20 Common Framework for Debt Treatments, run the risk that those creditors will incur losses and therefore CRA downgrade the developing country’s credit rating. The Common Framework is supposed to help debt-ridden countries and are the best chance for developing countries to reduce their liabilities but a ratings downgrading damage their prospects.
Standard & Poor’s, Moody’s and Fitch control more than 94% of outstanding credit ratings. They are basically an oligopoly influencing financial portfolio investments, the pricing of debt and the cost of capital. Their authority is also enhanced by the SEC (Security and Exchange Commission) who see them as the official CRA. Below are the ratings that each company uses.
We’ve been here before – conflict of Interest and the sub-prime crisis of 2008
Rating agencies are paid by the people whose products they grade and they are competing against other rating agencies for the business. Subsequently the rating agencies were being played-off against each other by the bankers in this market and this led to a systemic decline in standards and willingness not to check the underlying information as thoroughly as possible for fear of losing the deal. Even the rating agencies themselves admit mistakes were made is assessing sub-prime debt and that there were issues to do with data quality from their sources of research. However one has to consider whether the world have been better off if credit rating agencies had not existed as pension funds, bond funds, insurance companies etc would have had to do a lot more of their own research on what they were buying.
Remember before the credit crisis AAA investments mushroomed between 2000-2006 see graph below.
But consider the following:
Bear Stearns – rated A2 a month before it went bankrupt
Lehman Brothers – rated A2 just days before it collapsed
AIG – rated AA within days of being bailed out
Fannie Mae & Freddie Mac – AAA rating before being bailed out by the government
Citigroup – A2 before receiving a bail out package from the Government
Merrill Lynch – A2 before being sold to Bank of America
A2 is considered a good investment grade
Source: Credit-Rating Agencies Could Derail Economic Recovery – Project Syndicate