BEIJING, May 7 -- Credit rating agencies have never been so dreaded as Greece and other eurozone countries fight an uphill battle to calm market fears of an increasingly dangerous government debt crisis spreading across Europe.
Related German parliament lower chamber approves Greek aid package French parliament passes Greek aid plan White House says Greek reforms to take time Greek PM vows to bring debt-ravaged country new opportunities It is weird that firms such as Standard & Poor's, Moody's Investors Services and Fitch now wield the power of shoring up or busting national economies by simply designating the level of default risks of their government debt.
Standard Poor's downgraded the government debt of Greece to junk status last week, effectively pushing up the borrowing costs for Greece to unsustainable levels and leaving Athens with no choice but to turn to fellow eurozone countries and the International Monetary Fund for rescue.
As Moody's and Fitch are contemplating similar downgrades for Portugal and Spain, many fear the Greek debt crisis could spill over to other parts of Europe and drag weaker European countries into a debt quagmire.
Well aware of the potential devastating impact that rating agencies could have on the current delicate financial situation in many European countries, Germany's and France's leaders vowed Thursday to review proposed measures to regulate rating agencies as part of the efforts to improve economic and financial governance.
Many would wonder what rating agencies are exactly doing, who have made them so powerful on financial matters and what kind of roles they have played in the ongoing Europe debt crisis.
A commonly used definition has it that a credit rating agency is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves.In the financial world, risk detection and identification is a rather complex matter. Rating agencies, with in-depth research and advanced analytical skills, have made the financial system more efficient at pricing risks by grading different kinds of debt issuers and the debt they issue.
They help investors better understand the products they plan to buy and give some institutions a better chance of enticing investors.
Many financial regulators, like central banks, also widely use credit ratings to enforce capital reserve requirements of banks, insurance companies and other financial institutions.
For example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking regulators can allow banks to use credit ratings from firms when calculating their net capital reserve requirements.
Many institutional investors, such as pension funds, are required to only invest in products with a certain credit rating.
When Standard Poor's downgraded the sovereign credit rating of Greece to junk status, it effectively forced many financial institutions holding Greek government bonds to secure fresh funds to meet capital reserve requirements because the Greek government debt would no longer count as a solid asset.
Many institutional investors would also have to dump Greek government bonds or avoid new auctions because they were no longer allowed to invest in them under their regulations.
The heavy reliance on credit rating agencies by debt insurers, investors and regulatory bodies around the world has made these firms unchallenged kings in many financial dealings and endowed them with the privilege of having the final say on any credit risks.Government officials in Portugal and Spain have long complained that credit rating agencies are giving out misleading credit assignments to their sovereign bonds, pushing up their borrowing costs and escalating the situation significantly.
Credit rating agencies would claim innocence by saying the root causes for the current Europe debt crisis lie in the global financial crisis and lax government fiscal discipline. In short, credit rating agencies believe they are just the message bearer, not the one who created the ominous message.
But many believe credit rating agencies nevertheless could be blamed for disclosing risks too late or in a rushed mode.
Countries such as Greece have a long history of budgetary problems, but rating agencies didn't issue warnings until late last year.
In the past few years, and even at the pinnacle of the financial crisis, rating agencies still believed Greek government bonds were relatively safe investments.
When Athens admitted at the end of last year that its debt problems were much more serious than the government disclosed previously, rating agencies then rushed to dole out warnings and downgrades, creating a "vicious cycle."
The more warnings were issued, the more serious the Greek debt crisis became.
There is also a widely discussed conflict-of-interest problem with credit rating agencies. Debt issuers, not the investors, usually pay these firms. Credit rating agencies are more than likely to give out a higher grade to the debt they are asked to rate.
Many believe credit rating agencies played a part in triggering the global financial crisis by giving a high grade to certain kinds of low quality, complex investment products that turned out to be toxic and impeded the whole financial system in many developed countries.
Given the huge damage the financial crisis and the current Europe debt crisis have inflicted upon the financial system and the wider economy, it is expected regulators around the world will take a closer look at credit rating agencies and ways to rein in their behavior. |
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