Setting a poor standard
How seriously should you take ratings agencies such as Moody’s and Standard & Poor’s? One answer is “very”, since that is how governments and the media seem to treat them on the whole. Markets will likely react too, though exactly how and when is not as predictable. Broadly speaking, if the agencies downgrade you, media headlines will scream, policymakers could react. If they upgrade you, markets will see you as a safe bet for a big cheap loan.
But hey, isn’t that what the ratings agencies said about France until 2011 and Ireland until 2007? Before these and other European countries crashed, how come the ratings professionals had most countries at a virtually risk-free AAA? Yet at the time several economists had been warning about dangerous investment bubbles. Hardly dependable.
This may be one reason why markets shrugged off the S&P downgrading of France on 13 January. Also, they are being pragmatic: if everyone gets a downgrade then everyone’s the next best risk. And anyway, are the current AAAs really risk free? Hardly.
Look at Europe: How come S&P downgraded France but not Germany? Surely, given the euro, if you downgrade Peter, you downgrade Paul. Is their downgrading based on rigorous financial criteria and astute economic judgement, or something more political, such as opposition to the Tobin tax which France supports and Germany opposes? If the ratings agency wanted to express a political agenda, such as being anti-euro, then what better way to do it than to take a poke at the delicate relationship at Europe’s heart. Nothing sinister about that: economics, business and politics are the most ancient of troikas. Nor are ratings agencies mere messengers, they are players and stakeholders in the unfolding drama of the world economy.
Interestingly, neither Moody’s nor Fitch, the other two major ratings agencies, saw fit to downgrade France, and in one case, said it would uphold the highest rating till 2013. Ratings agencies are businesses first and foremost, and demarking themselves from their competitors is important. But if Europe falls apart, wouldn’t Germany then become a risky investment? Germany depends on Europe’s institutions being healthy, and in the words of a business lecturer friend of mine, it would be a fool to let it fall apart. The political risk is probably on the upside.
So, how seriously should rating agencies be taken? By downgrading France, S&P’s was acting like an elephant in a china shop, though hopefully for anyone who supports the euro, the elephant was just a paper one.
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