Thursday, 11 August 2011

Are Rating Agencies a boon or a bane to the world economy, are they really necessary

What is a Downgrade?
A change in the rating of a bond or other security in a downward direction. For example, a bond that had previously been rated AAA may be downgraded to AA. Downgrades are considered detrimental because they mean the ratings agency believes that the issuer of the security is less likely to be able to fulfill its obligations, such as coupon payments. A downgrade increases the cost of funds for the issuer because investors expect a higher return in exchange for the increased risk on the security.

I don't know much about Credit Rating Agency and Credit downgrade until that fateful day in August that US Credit rating agency Standard and Poor's downgraded the US debt rating:

S.& P. Downgrades Debt Rating of U.S. for the First Time
The company S& P, one of three major agencies that offer advice to investors in debt securities, said it was cutting its rating of long-term federal debt to AA+, one notch below the top grade of AAA. It described the decision as a judgment about the nation’s leaders, writing that “the gulf between the political parties” had reduced its confidence in the government’s ability to manage its finances.

“The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge,” the company said in a statement.

The Obama administration reacted with indignation, noting that the company had made a significant mathematical mistake in a document that it provided to the Treasury Department
on Friday afternoon, overstating the federal debt by about $2 trillion. 

 “A judgment flawed by a $2 trillion error speaks for itself,” a Treasury spokeswoman said.

The downgrade could lead investors to demand higher interest rates from the federal government and other borrowers, raising costs for governments, businesses and home buyers. But many analysts say the impact could be modest, in part because the other ratings agencies, Moody’s and Fitch, have decided not to downgrade the government at this time. 
Read in full here.

When the Dow Jones went south after the Standard & poor's downgrade, I finally realise the magnitude of the problem.... when the US sneezes everybody around the world could get the flu:

Global stocks fall on first trading day since downgrade of U.S. debt by Standard & Poor's

So comes the question, are the Rating Agences more powerful than the most powerful Government on this planet?

Maybe the following article could share some light and I would like to share this article with friends:

Debt Police Go Rogue

How did a bunch of unelected corporate suits get the power to wreck the global economy? Zachary Karabell on the real bogeymen of the debt debacle: unaccountable ratings agencies.

As the debt-ceiling storm intensifies, some reports indicate that the White House, and perhaps the global financial markets, are less concerned with paying bills after Aug. 2 than with credit-rating agencies imposing their first-ever U.S. government downgrade, from AAA to AA+.

How did it come to this—that a trio of private-sector companies could wield such enormous influence? More specifically, a trio that has proven chronically behind the curve, analytically compromised, and complicit in the financial crisis of 2008–09 as well as the more recent euro-zone debt dilemmas? Somehow, these inept groups again find themselves destabilizing the global system in the name of preserving it. While there are more than 100 credit-rating agencies worldwide, three—Moody’s, Fitch, and Standard & Poor’s—occupy their own particular universe, the products of a New Deal ruling from the SEC that enshrined "nationally recognized statistical rating organizations” to ensure that the bonds held by insurance companies, banks, and broker-dealers were appropriate for their capital requirements.

From this well-intended decision, three new private-sector firms attained the status of government regulators but with none of the oversight. Undoubtedly there are many honorable, meticulous, and intelligent people working for these companies. But throughout the last decades of the 20th century and into the 21st, the decisions of the agencies about the creditworthiness of emerging-market countries imperiled financing needs, and we have seen a repeat of the crises of the European periphery, as the best plans to restructure the debts of Ireland, Portugal, and Greece have been jeopardized by the rigid application of formulas that the ratings agencies apply.

These agencies also evaluate private debt. And it was their continual stamp of approval on trillions of dollars of ultimately worthless mortgage-backed securities that allowed pension funds, endowments, and municipalities to buy them up in the erroneous belief that they were safe and sound. That decision cost taxpayers hundreds of billions of dollars.

Yet here they are again, threatening to downgrade the debt of the United States—potentially costing taxpayers hundreds of billions, again, in the form of higher interest payments—because they don’t like the messiness of the political process and they don’t approve of the level of debt relative to GDP, so said David Beers of S&P.

But, really—and I mean this in the most respectful way—who the hell is David Beers and who elected him to be the arbiter of the American financial system?

David Beers is the head of global credit risk for S&P. He has about 80 people working for him, and they rate countries throughout the world. They recently downgraded Greek debt almost as low as it can go, into the C range, which will make what appeared to be a rational plan by the French and the Germans to restructure Greek debt and avoid a meltdown of euro-zone banks that much more complicated. No doubt they are all well trained and have a better grasp of the complexities and trustworthiness of debt than most, but it still begs the question of how one company and a staff of 80—about what a smallish Nasdaq company might have in its accounting department—came to occupy such a central position that their assessments can throw the global system for such dangerous loops.

Then there is Deven Sharma, head of S&P, which is itself a division of the global media company McGraw-Hill. His résumé would seem one of your run-of-the-mill high-level achievers from a decent M.B.A. program: an executive vice president of strategy for McGraw-Hill and a consultant at Booz Allen. Yet somehow, he testified before Congress yesterday that even if a debt deal is struck, the U.S. still faces a possible downgrade—with all the attendant potential costs of higher rates, more capital cushion required for institutions to hold U.S. Treasuries.

I don’t doubt the personal integrity of these individuals, and, frankly, the power of their agencies is the product of endless buck passing: first on the part of the SEC at various points in the 20th century, then of everyone from bank regulators to insurance regulators, and in the institutional world, pension boards and brokers, all of whom wrote into their due-diligence contracts that only “investment grade” bonds could be held for certain purposes. Rather than force the fiduciaries of each of these to do their own due diligence, they were all given the out that if one of the designated ratings agencies certified the credit worthiness, that was enough.

Yet the result is that a few individuals who answer to no one but their own corporate boards can cause massive dislocations. That’s absurd.

To those who say that it’s unfair to blame the messenger—and that on the whole, these agencies are simply calling it as they see it and drawing attention to real risks—there is the pesky fact that they have a legacy of either being chronically late (the mortgage crisis) or then too eager to downgrade (overreaction to the mortgage crisis). And even if they were as good as they could be, they are still simply three companies with a few hundred unelected people making calls that drive the entire global financial system.

There is one last glaring question: should these agencies even be rating a sovereign entity such as the United States? The dollar is now a global currency of commerce, and U.S. Treasuries are a form of safe-haven currency. It’s not as if the world is unaware of the economic issues of the U.S. The Chinese don’t need Moody’s to tell them about the risks of holding a trillion dollars of U.S. bonds. Shouldn’t the “creditworthiness” of the United States, or the viability of a European debt plan for Greece, be left to the determination of investors large and small worldwide along with the governments of those countries and their electorates? The success or failure of their plans will be evident soon enough, and subject to the thumbs up or down of the people, without the ratings agencies piling on or offering a view.

But such questions don’t help us this week. Frankly, the best possible outcome would be for them to downgrade the U.S.—and for the world to shrug, with rates set by the multitude of buyers and sellers. That would at least demonstrate that these emperors, clothed though they are, wear very frayed robes. Read in full here.

Zachary Karabell is president of River Twice Research and River Twice Capital. A regular commentator on CNBC and a columnist for Time, he is the coauthor of Sustainable Excellence: The Future of Business in a Fast-Changing World and Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends on It.
We used to have currency speculators who caused havoc to the global economy in the late 90's, those currency traders have been tamed but are the rating agencies becoming like the infamous currency speculators. Rating Agencies decides on the credibility of a company or a nation's debt but the trillion Dollar question is who decides on the credibility of the Rating Agencies, are they the law unto themselves?

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