Imagine being told you have to lose weight. Of course you can’t, you are thin and beautiful, but suspend your disbelief for this short thought experiment. You are warned that without drastic action, your very life is in danger. So you do what you are told. Yet every time you forgo a biscuit, every time you disembark deliriously after an hour on the treadmill, you are injected with lard by those very people who told you to get healthy. That would be a little annoying. And that’s essentially how José Manuel Barroso, President of the European Commission, feels.
Portugal’s credit rating was downgraded four notches in July for reasons that will not astonish anyone: high debt and low growth. Portugal received a €78bn bailout from the European Central Bank in May, due to the already high cost of borrowing it was facing. Essentially, no one would lend them money at a reasonable rate, so they had to go to the ECB. Subsequently Moody’s, the credit rating agency, promptly downgraded Portugal anyway. The downgrade is a result of Moody’s belief that Portuguese debt is more risky because a default is more likely. Yet in downgrading their credit rating, thereby making Portugal’s cost of borrowing even higher, they make a default much more probable. It is a painfully depressing self-fulfilling prophecy.
There are three main credit rating agencies, each with names more ominous than the last. Fitch, Moody’s and Standard & Poor’s. Rating agencies are the people who calculate the risk involved in financial transactions, and help set the price of German debt much lower than say that of Argentina. So who is the European Union to judge and complain? After all, the rating agencies are experts, and the Eurozone is simply broke and bitter about it. The problem begins, as so many seem to do these days, with the financial crisis that began in 2007, and which people optimistically thought had ended in 2009.
The crisis itself began when hundreds of billions of dollars of US mortgage debt was rated as triple-A, the safest possible, but turned out to be worthless. Who rated these junk securities as triple-A? You guessed it, Fitch, Moody’s and Standard and Poor’s. A combination of conflicts of interest, and some cases where the rating agencies didn’t understand the securities they were rating, led to financial ruin. The US Financial Crisis Inquiry Commission called the rating agencies “essential cogs in the wheels of financial destruction”. Many parties were responsible for the financial crisis – banks, rating agencies, governments and consumers. The impunity enjoyed by banks and bankers is notorious. Less well known is that of the rating agencies.
Standard & Poor’s demanded $4trn in cuts by the US government to keep their triple A status, and they haven’t got it. But say what you want about members of Congress (and I would be perfectly content with the US political system being downgraded to junk status), they do enjoy democratic legitimacy. If Standard & Poor's decides to downgrade US debt, it will be a fine example of the supremacy of financial leaders over the political. But who regulates the regulators? EU leaders want to set up their own, more dovish rating agency, but that will not solve the problem.
I leave you with this thought: the World Bank has hired as its new Treasurer Madelyn Antoncic, who is described on the organisation’s website as an "experienced senior executive from the financial industry who has been active in the regulatory and policy debate". Experience she gained as Chief Risk Officer from 2002-2007 at Lehman Brothers. You cannot conceive of the sheer tonnage of canned tuna in my immediate possession.
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