Don’t be so Moody

In the minds of many pro-European left-wingers, a new ogre is taking the place of old pones: the credit rating agencies. James Carville famously said that he wanted come back as the bond markets in a next life; coming back as a credit rating agency might be the next best thing. The agencies are blamed by many on the Continent for being too tough on a range of assets and too American to understand Europe. And EU Commission President Jose Manuel Barrosso has talked about a “bias” against European assets.

Worldwide, there are about 150 credit rating agencies. But many of them are only regional, while three U.S. companies dominate the market: Standard & Poor’s, Moody’s and Fitch. To counter this imbalance, the idea of an EU-backed credit rating agency occasionally surfaces. Only a month ago, German Chancellor Angela Merkel floated the concept to a group of German legislators. And the EU has already established a new market supervisory authority to oversee the rating agencies, the European Securities and Markets Authority.
                
Now, after Moody’s slashed its rating of Portugal to junk, pushing the country’s borrowing costs upwards, EU officials have begun muttering about barring ratings of countries in receipt of bailouts. They are worried not only about the impact in Portugal — given the prospect of even more bailing-out to be done — but also the impact on the Euro, which lost against the dollar upon the news of Moody’s decision. Expect the idea of a European agency to gather pace.

But this seems like blaming the Met Office for the weather. Since 1909, credit rating agencies have played a crucial role in assessing the credit worthiness of a company or a country and their debt obligations. They are of course not alone. Since publicly available sources of information pertinent to investment values are far greater than they were in the day when rating agencies first appeared, agencies ought in principle to be less in demand. Nor are the agencies above criticism. In the late 1990s, credit rating agencies were said to have aggravated the East Asian crisis by excessively downgrading those countries. This is the kind of criticism that is now gaining traction following Moody’s decision on Portugal.

But despite this, the agencies remain — and are largely trusted by the markets. Blaming the messenger, rather than addressing underlying weaknesses, contributed to Europe’s mess in the first place. Instead of establishing a European agency, policymakers should focus on the reforms needed to regain the trust of the markets.