Credit Rating Agencies: Just how much we should trust them?

“As investors buy high-rated assets and sell the downgraded, we must question the people behind-the-scenes who set the standards, and the power they have over global investment decisions.”

By Ellie Chan, Staff Writer

by Thafeth (Flickr)

The Congress is pressing on with its investigation on credit rating agencies and whether the firms overlooked crucial information that led to MF Global Holdings’ bankruptcy. The chairman of the House Financial Services subcommittee sent letters to the chief executive of Moody’s and the President of Standard and Poor’s (S&P) inquiring on the decision process that determined MF Global’s credit score.

The United States is not the first to question the trustworthiness of rating agencies. EU leaders expressed frustration towards these firms in 2011 at the height of the Eurozone crisis. The three most influential companies – S&P, Moody’s, and Fitch – grade government and corporate debt (AAA, as the top notch rating) by diving into financial documents and analyzing current events. The credit score aids investors in their decision to invest and improves transparency in the system. Few understand why these companies are as influential as they are, but they undoubtedly have enormous power over global investment decisions. Markets esteem credit ratings as one of the most important indicators of the quality of assets, and a downgrade from any one of these agencies can trigger a massive sell-off.

As the referees on the sideline, who watch as events unfold and blow the whistle when needed, rating agencies have become one of the players who kicks the ball and alters the game. They push investors towards decisions that otherwise may not have occurred to them. When EU member states were trying to contain the crisis last year, S&P, Moody’s, and Fitch downgraded European sovereign bonds at the worst timing: a few days before critical EU summits, or before bond auctions. They destroyed market confidence at the most crucial moments for Europe and because of these untimely downgrades, the rescue cost for Europe went up, and bond auctions yielded disappointing selling results.

The importance we put on rating agencies is a mystery. We cannot forget that these are the same firms that freely gave out top ratings to worthless mortgage debt that led to the financial crisis in 2008. They failed the world economy then, and their new-found status is ironic and almost wrong. Today, they stand as the accuser pointing fingers at corporations and countries that are in trouble, when only three years ago, they were the accused, shying away from the fact that they dragged the world into the worst recession since 1930.

Rating agencies claim their reports as “opinion”, and we should treat them as such. It is illogical to allow three ratings companies, ultimately three Chief Executives, possess all the power to rock financial markets globally. They already did in 2008, and it has not been an easy ride since.

ARB Team
Arbitrage Magazine
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