Rating Rodents (Part 2)
Rating Rodents (Part 2)
The global fallout of systemic manipulation involving ratings agencies should not be a surprise, especially since the business model for ratings agencies are to get paid handsomely by their clients, thus “buying a healthy rating”, or else there will be no repeat business? The rating process starts with a “rating agreement” entered into by the rating agency and the client, or the issuer, wanting their securities rated1.
Although there are guidelines (International Organisation of Securities Commissions & Financial Stability Board), in terms of factors to consider when doing a risk assessment, the process is still discretionary since “rating” has been defined as “an opinion regarding securities, ...”1. The ratings agencies are thus not bound to the rating or advice they give, then add to this that more than 50% of investors in stock markets are mainly market illiterate1, then the scale and size of the systemic time-bomb we are sitting on, should become clear. It suggests measures taken to date are insufficient (e.g. the US’s SEC scrapping mandatory rating requirements for bond issues, whilst other experts are pushing for the removal of mandatory rating of securities). This reactionary logic flows from rating agencies having “vested interests” i.e. systemic corruption across the EVC? of the financial sector, making it difficult for sound decisions to be made1, 2. There are 2 models of how credit ratings agencies are paid: “Issuer-pays & Subscriber-pays”, neither of which allows for the required robustness and assurance sought by investors. Other ideas, like fixed prices can avoid “rating-shopping” which is where clients shop around for an agency that will give them the best rating. The German idea on reformation was to create a global independent body: International Non-Profit Credit Rating Agency (INCRA), but then it may very well end up with geo-political challenges. Although all of these ideas are improvements, the industry is not undertaking a systemic perspective, and as such will be unable to find the ideal solution framework having the least propensity for corrupt & fraudulent tendencies2. Credibility in credit rating agencies should for all intents and purpose be nil, yet it is not, suggesting we are all seriously under-estimating the systemic consequences yet to manifest. The Italian raid on S&P’s Milan office; the US Justice guilty verdict; the Greek tragedy; Ex-employee’s and experts of ratings agencies speaking out on corruption and manipulation3, still have not yielded the required radical improvements. Academic and economic experts blasted the ratings agencies for being: Lenient; Subjective; Lack of a standard ratings table (e.g. A having +ve /–ve, etc.)4. St. Gallen’s research found ratings to have a direct impact on countries (the cost of capital or lending money), to the extent that it creates disequilibrium or multi-equilibria4. So if one consider Nationalistic ideals & Geo-politics, it will not be far-fetched to see how access to capital and low interests rates can be used to destroy economies at will? The Scandinavian & Greek examples should be sufficient evidence of this reality, as well as the research by Heidelberg University, detailing critique on rating agency’s “home country favoritism”. In other words, rating agencies from a specific country, tend to be more lenient toward that country4. Since a rating is ideally related to the level of risk, which affects the interest rate being charged, the debt is inversely proportional to the risk5. Investors use these “ratings & opinions” to make key decisions. Investors implicitly assume that the rating and opinions are unbiased, and are oblivious to the fact that no consistent formula exist to determine an institutions credit rating, thus being subjective5. Advantages of robust rating agencies are supposed to ensure that: Good institutions obtain good rates (incentive to improve institutions); Provide warning of risky investments; Provide guidance on risk-reward ratios5. However the agencies have revealed major flaws like: Subjectivity of evaluations; Inconsistency; Conflict of interest; Accuracy & efficacy of ratings and opinions5. By rating "creditworthiness" of Countries, Companies and Currencies, ratings agencies act as a barometer to investors like for example a AAA is the highest standard, whilst any rating below BBB are referred to as “junk bonds”6. It is then alarming to continue to allow these agencies to direct and guide large pools of funds, since their “opinions” result in a State or Government paying high interest rates, which a cost passed onto citizens.
References
- Rishi, A., 2016, A critique of credit rating regulations in India, The weekly, Corporate law, 2016;
- Udemans, F., 2012, The golden thread: escaping socio-economic subjugation, an experiment in applied complexity science; Author House;
- Pym, H., 2012, Do credit rating agencies threaten our financial stability, Economics correspondent, BBC News, 28 February 2012, Business;
- Grene, S., 2014, Big three credit ratings agencies under fire, Financial times, May 04, 2014, 3:01AM;
- Smith, K., 2014, Agencies & How They Work, Money crashers, posted in Bonds, Stocks;
- Kingsley, P., 2012, How credit ratings agencies rule the world, The Guardian, Wednesday 15 February 2012 20.00 GMT;
- Younglai, R. & Da Costa, A., 2011, When ratings agencies judge the world, Reuters Business, Washinton-London, Aug 2, 2011 2:01pm EDT?Insight;