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On 28 April 2010, two minutes before the end of trading in London, the credit rating agencies (CRAs) struck. This time it was Standard & Poor (S&P), and this time it was Spain. S&P, one of the ‘big three’ CRAs, downgraded Spain’s debt grading from AA+ to AA, and the stock market plunged as traders worried about contagion and the possibility of a new meltdown in the world economy.
Within a few days, the Spanish government had announced a new package of austerity measures, aimed at reassuring the markets of its capacity to reduce the 11 per cent budget deficit. The measures include cuts in civil service wages by an average of 5 per cent in 2010.
So what is it about the mere opinion of a private firm on the capacity of a government to repay its debts that can create such panic for the markets and ensuing ‘austerity’ for the working class in countries across Europe and beyond?
The big three CRAs – S&P, Moody’s and Fitch’s – are not just any old private firms. Between them, they probably have more direct power over democratically-elected governments than any other corporate entity in the world. They continue to maintain this extraordinary power, in spite of very clear evidence that they were in large part responsible, through a mix of incompetence and downright fraud, for the financial crisis of 2008.
Their power has its roots in the near collapse of the financial system in the early 1930s, when bank regulators decreed that banks could hold only ‘investment grade’ bonds determined by the ‘recognised rating manuals’ already being produced by these three firms. In effect, the US outsourced the rating process. This has never changed, and was reinforced in 1975 with the adoption of the three firms as ‘nationally recognised rating organisations’.
This created a cartel at the heart of the supposed free market, with Fitch’s, Moody’s and S&P effectively left to do as they pleased. This they did with gusto, moving away from their previous investor-pays business model towards a more lucrative issuer-pays model whereby the firms issuing bonds pay the CRAs for their ratings.
The potential for massive conflict of interest and downright corruption with the issuer-pays model is not hard to spot, and so it came to pass. By the mid-2000s the credit rating agencies were up to their necks in dodgy dealings with the firms whose bond issues they were supposed to be rating objectively.
Most notoriously, they continued rating sub-prime ‘collateralised debt obligations’ (CDOs) at AAA, in the face of all real-world logic about the creditworthiness of these oversold mortgages. As the bubble grew, so did the fat profits of the CRAs, secure in the knowledge that they were, by force of legislation, just about the only players in town.
The Obama administration is now looking to reform some of the greater abuses of the credit rating system, some of which have come out in extraordinarily damning details in hearings in recent months. Nevertheless, the efforts that are being made to move away from the corrupt issuer-pays model are designed to protect investors, not those who have suffered most from the global recession.
Thus, when S&P downgraded Greek bonds to ‘junk status’ just as the Eurozone authorities were putting together their rescue package, the Greek economy was sent spinning into a self-fulfilling spiral of decline, where bonds can only be sold at huge interest rates, which adds to the deficit problem, which in turn makes future bonds harder to sell and creates further calls for austerity on a government already brought to its economic knees.
At the start of 2010, Pierre Cailleteau of Moody’s outlined what he foresaw as regards sovereign debt: ‘In several countries … a great sacrifice is required from the respective populations … In 2010, the ongoing crisis will further test such fortitude. We are closely monitoring signs of economic rebound as well as of political and social tension as early indicators of the sustainability of fiscal efforts.’
Three Greek bank workers were killed by an incendiary device in the ‘political and social tension’ that followed the credit rating agencies’ opinion on Greece. Pierre Cailleteau from Moody’s, and his colleagues from S&P and Fitch’s, weren’t around to throw incendiaries that day – but it is they who started the fires.
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