The credit ratings agency has warned it could downgrade all 15 eurozone countries. Why does this matter?
If you thought that there wasn’t enough pressure on eurozone leaders to resolve the debt crisis, you were wrong. In a surprise move, the credit ratings agency Standard and Poor’s (S&P) has put most of the zone on “credit watch”. This means that six countries with top AAA ratings – including Germany and France – now face a 50 per cent chance of seeing their ratings downgraded.
This could pose serious difficulties for Europe. Its rescue fund (the European Financial Stability Facility) relies on France and Germany’s AAA status to keep its own top rating. Downgrading these countries could aggravate the debt crisis further by making it more expensive to bail out troubled eurozone countries. The lower the credit rating, the more interest attached to loans in order to attract investors.
We’re clear that S&P wields huge power, then; but who exactly are they, and how do these agencies operate?
One of the big three credit ratings agencies (along with Moody’s and Fitch), S&P is a US based financial services company that rates a company or country’s financial stability. The checks they run on firms, nations or financial products are comparable to the checks a bank runs on you before granting you a credit card.
There is a long history behind them. Poor’s started life as a journal in 1860, moved into the ratings business in 1916, and merged with the Standard Agency in 1941. It followed in the footsteps of Moody’s, which rated American railroad companies around the turn of the century.
Markets continue to rely on these agencies as the only truly “independent” marker of creditworthiness. Despite this, however, they collect fees from the very companies that they rate, creating a conflict of interest in a system that was clearly shown to be flawed during the 2008 crash. In the New Statesman last year, former financier Alex Preston explained how these agencies operate:
Credit rating agencies opine on the creditworthiness of companies, countries and the complex asset-backed securities whose unravelling kick-started the credit crunch. They score each particular entity using a spectacularly arcane “model” that spits out a rating like an exam grade – anywhere from D (for dunce) to AAA (massive swot). The UK and US governments are rated AAA. So were the vast majority of sub-prime securitisations created during the boom years. Ratings aren’t optional – if you want to issue a bond or loan, you need to get a rating. And if the agencies don’t like what they see, they hit you with a low (or “junk”) rating, meaning that you have to pay an awful lot more to raise money from investors.
In the aftermath of the financial crash, it appeared that ratings agencies were finally coming under serious scrutiny from the regulators, but this has not been realised. Despite the role of these firms in the crash — they gave mortgage-backed securities the safest ratings possible, fuelling enthusiasm for these risky investments — they continue to hold an enormous influence over the markets and, indeed, countries’ fiscal policy. An announcement such as today’s will have a powerful global ripple effect.
A brief look at the last six months demonstrates this. S&P’s decision to downgrade the US at the start of August caused turmoil in the financial markets, while in October, a false statement that it had downgraded France caused French bond yields to surge. The French government was so angry that it threatened to ban rating agencies from commenting on France again.
There are moves underway in Europe to regulate the credit ratings agencies more tightly, reducing the power of these big three firms; but for the time being, the markets — and some of the world’s biggest economies — remain at their mercy.