Debunking the Bogeyman: What role do credit ratings agencies actually play?

Please chip in to support more articles like this. Support rabble.ca today for as little as $1 per month!

Photo: wikimedia commons

It's refreshing to see some Canadian mainstream media columnists challenging the influence of Moody's and the other big credit ratings agencies (CRAs). On July 14, the Toronto Star's Martin Regg Cohn wrote "... it's unclear that those overrated credit rating agencies still hold the sway they once did." On July 17, Rick Salutin questioned their "influence and arrogance."

Criticizing the so-called "Big Three" CRAs -- Moody's, Standard and Poor's (S&P) and Fitch Ratings -- has become almost commonplace elsewhere, a kind of collective debunking of the bogeyman. But in Canada most pundits still treat the CRA pronouncements as gospel.

That was evident in early July when Moody's placed Ontario on a "negative outlook" for a possible ratings downgrade -- resulting in dozens of scary media stories across Canada. For example, The Globe and Mail called the Moody's pronouncement "a shot across the bow" for the newly re-elected Wynne government, warning that S&P "can be expected to pass judgement soon."

Economist Kaylie Tiessen addressed the alarm: "Let's be clear, this was not a downgrade in the credit rating, as some have suggested. It's more like the equivalent of a sad face emoticon..." Linda McQuaig criticized the deficit fear-mongering by pundits following Moody's "intervention."

The Toronto Star's Cohn and Salutin challenge the most vulnerable aspects of the CRAs -- their credibility and reputation -- which have been quietly eroding as more information emerges about their role in the financial meltdown six years ago. As Salutin noted, "They were indispensable in creating the housing bubble, bailouts, demands for austerity -- plus a living hell for U.S. homeowners and entire European nations."

'Roiling the markets'

The Big Three CRAs -- which control 95 per cent of the global bond-ratings business while headquartered in the U.S. -- argue that their ratings are merely "opinions" and are protected under the U.S. First Amendment. (The fourth largest CRA, Canada-based DBRS, has only a tiny portion of the business by comparison.)

But the Washington Post's Alec Klein reported in 2004 that the agencies can "with the stroke of a pen, effectively add or subtract millions from a company's bottom line, rattle a city budget, shock the stock and bond markets and reroute international investment...Yet there is no formal structure for overseeing the credit raters, no one designated to take complaints about them, and no regulations about employee qualifications." With the flow of international capital in a globalized economy, nations "have been forced to accommodate" them.

Klein used the example of Moody's decision in the early 1990s to place Canada's sovereign debt "on review for a possible downgrade." The announcement became news "spun around the world," dropping the value of the Canadian dollar, forcing the Central Bank to buy back money, while investors "dumped Canada's bonds and drove their interest rates higher, which would cost the government hundreds of millions of dollars."

PM Paul Martin "acted quickly to allay Moody's main concern...insert[ing] stronger language into his budget speech to emphasize the need to attack the nation's debt, using such sturdy terms as putting 'our fiscal house in order' and citing the ‘dangers of the deficit.'" He then cut funding for unemployment insurance and health care.

McQuaig revealed in her book Shooting the Hippo the extent to which the early 1990s Canadian "deficit crisis" had been manipulated by right-wing think tanks, bankers and corporations, even to extent of their trying to pressure Moody's to issue harsher reports, which it refused to do at the time.

But as Klein noted, Moody's warning "was enough to roil financial markets and send a major sovereign nation scurrying to restore order." Whether Paul Martin was pushed, or willingly jumped, into making austerity budget cuts is a valid question.

Selling triple-A

Since the 1970s the CRAs (aside from sometimes issuing unsolicited ratings) are paid for their services not by investors who want to know the safety of a debt bond issued, but by the issuers themselves -- who obviously have a stake in getting a triple-A rating for their investment vehicle.

These factors came into play during the U.S. subprime mortgage bubble, when some investment banks were paying more than one million dollars for triple-A ratings on what turned out to be toxic assets.

An investigation by McClatchy Newspapers (Oct. 18, 2009) reported: "Ratings agencies thrived on the profits that came from giving the investment banks what they wanted [triple-A], and investors worldwide gorged themselves on bonds backed by U.S. car loans, credit card debt, student loans and, especially mortgages. Before granting AAA ratings to bonds that pension funds, university endowments and other institutional investors trusted, the ratings agencies didn't bother to scrutinize the loans that were being pooled into the bonds. Instead, they relied on malleable mathematical models that proved worthless."

'Key enablers'

No wonder the U.S. Financial Crisis Inquiry Commission report (January 2011) called the CRAs "key enablers of the financial meltdown."

As the U.S. Center for Public Integrity recently summarized: "Wall Street firms created wildly complex securities based on junk subprime mortgages and sold them to pension funds, insurance companies and other Wall Street banks because they carried the golden seal- AAA." In the first two weeks of July 2007, the companies issued top ratings on "more than 2,000" mortgage bonds and investment vehicles. "Then, on July 10, 2007, Moody's downgraded $5.2 billion in mortgage bonds, and S&P put $7.35 billion-worth on credit watch. Over the next few months the companies cut their ratings on thousands more mortgage bonds and collateralized debt obligations [CDOs] that depended on those bonds. The foundation of the U.S. financial system began to crumble." 

The U.S. Senate's Permanent Subcommittee on Investigations' April 2011 report stated that "perhaps more than any other single event," the sudden mass downgrades of residential mortgage-backed securities and collateralized debt obligation ratings were "the immediate trigger for the financial crisis."

Was it some kind of "pump and dump" operation? Nobody's proved that yet. But there is some evidence that the Big Three CRAs had a more active role in the crisis than mere "enablers."

 

Joyce Nelson is an award-winning freelance writer/researcher and the author of five books.

Photo: wikimedia commons

Further Reading

Thank you for reading this story…

More people are reading rabble.ca than ever and unlike many news organizations, we have never put up a paywall – at rabble we’ve always believed in making our reporting and analysis free to all, while striving to make it sustainable as well. Media isn’t free to produce. rabble’s total budget is likely less than what big corporate media spend on photocopying (we kid you not!) and we do not have any major foundation, sponsor or angel investor. Our main supporters are people and organizations -- like you. This is why we need your help. You are what keep us sustainable.

rabble.ca has staked its existence on you. We live or die on community support -- your support! We get hundreds of thousands of visitors and we believe in them. We believe in you. We believe people will put in what they can for the greater good. We call that sustainable.

So what is the easy answer for us? Depend on a community of visitors who care passionately about media that amplifies the voices of people struggling for change and justice. It really is that simple. When the people who visit rabble care enough to contribute a bit then it works for everyone.

And so we’re asking you if you could make a donation, right now, to help us carry forward on our mission. Make a donation today.

Comments

We welcome your comments! rabble.ca embraces a pro-human rights, pro-feminist, anti-racist, queer-positive, anti-imperialist and pro-labour stance, and encourages discussions which develop progressive thought. Our full comment policy can be found here. Learn more about Disqus on rabble.ca and your privacy here. Please keep in mind:

Do

  • Tell the truth and avoid rumours.
  • Add context and background.
  • Report typos and logical fallacies.
  • Be respectful.
  • Respect copyright - link to articles.
  • Stay focused. Bring in-depth commentary to our discussion forum, babble.

Don't

  • Use oppressive/offensive language.
  • Libel or defame.
  • Bully or troll.
  • Post spam.
  • Engage trolls. Flag suspect activity instead.