Pass and Fail: why we put up with the risks of the ratings agencies

By Luis Martí, in Madrid | We were warned from the beginning of December of a massive review of ratings by Standard & Poor’s (S&P), so what happened last January 13 did not come as a surprise. The reaction in the political class has been mixed. Rejection in Brussels, and outrage among renowned German politicians at this ‘Anglo-Saxon maneuver’ to ‘attack the Euro’ (it being understood, maybe, that ratings included ‘the German management of the crisis?’) This in contrast with the German chancellor, who simply said

“they are doing their job, we do ours…”,

or with the approval of the Italian premier Mr Monti, who certainly intends to wield the report to reinforce his negotiating strategy with Berlin. And also in contrast with the recovery of the Italian and Spanish risk premium since the 16.

This rating review, as the previous ones, was sure to be a media success. The success probably lies in the simplicity of the system that generates a single ‘mark’ that expresses –according to the definition of the agency– the degree of trust a country deserves from investors. The headlines are guaranteed.

Bridging the differences, it may be interesting to recall here an interesting IMF annual publication: the Article IV report on the economy of each member country. It is a long document, a bit dense, with controversial remarks on economic policy (which many governments try to negotiate before its publication), and an enormous wealth of statistical data. Apart from the interest the IMF’s views may warrant, the amount of information constitutes an added value of extreme usefulness for any analyst of country risk. But the content is technical and an ‘Executive Summary’ can not be reduced to a couple of flashy headlines. For this reason, its impact on the media is generally limited or non-existent.

Although the concerns are similar –country risk– the agencies’ documents go down a different path. It’s not an issue of superficial comparisons. Each organization elaborates documents to fit its purposes and its audience. S&P explains its decision in a Frequently Asked Questions format and their answers, inevitably, lead to some observations.

We assume that S&P will have internally carried out economic studies following their own methodology. But it shares answers that are not very satisfactory. The text abounds with the same comments that politicians, specialized media and European researchers exchange on a daily basis. The added value contributed by this document, as well as its data and its analysis, is rather scarce. Some examples:

Disappointment with the results of the December summit, which did not produce the desired breakthroughs: S&P characterizes the long debate over European policy as one of the systemic stress areas to which the euro zone is exposed. Of course. It could hardly be otherwise. The euro zone requires the conciliation of conflicts of interest between governments that are subject to established institutional processes. It is a complex dynamic that slows down the integration project but that is inherent to the European political systems: the agency is rating no other than the governance of Europe, as Philip Stevens wrote a few days ago (FT January 20). Is it realistic that S&P judge the political structuring of the euro zone and of its members?

S&P superficially mentions some burning questions such as growth vs. austerity and its frightening consequence, ‘reform fatigue’. The idea that forcing austerity only leads to greater public deficit and –following the logic currently in force in the Euro zone– to another dose of austerity is nowadays being discussed in all euro zone forums, political and professional. It will be Mr Monti’s central issue and presumably the Spanish authorities’ too. There is no easy solution, as there isn’t for many issues that gradually are being worked out within the EU, but to anticipate failure seems to have more apriority than analytical rigor.

There are disconcerting observations: the reformist governments “may stumble with powerful domestic interest groups” that could hinder reforms. Naturally. What contribution does the agency make here? Economic policies are not neutral in any country. They benefit or harm some groups more than others. Every framework of measures in force in any country has been set up by circumventing or dealing with problems by impositions, social concessions and counter concessions. The reform programs in progress are subject to similar processes. I do not see what S&P may be basing its anticipation for the failure of European managers in handling problems inherent to traditional political activity.

The reasons for downgrading Italy and Spain appear to be two: the agency considers that its “crisis management tools” may not be adequate, and that they are countries that are particularly vulnerable to the sudden worsening of the markets. The enormous energy, both technical and political, that Monti’s new administration has proven to have has paradoxically earned the country a drop to triple B+, such as in the cases of Ireland. And Spain lost –preemptively– two positions before the agency could understand and analyze the imminent program of the Spanish government.

The value added by the agency’s issuing its ratings seems to be, simply, the ‘opinion’ that its grade reflects: the markets do not ask for data or analysis but rather they are content with a concentrated judgement based on one or two letters. Only the weight of an undisputed auctoritas can explain the markets’ sensitivity to the announcement of a rating. But, unlike the Roman one, this auctoritas has not arisen spontaneously. It was granted by U.S. law and confirmed by many models of regulation that, despite Brussels’ and many politicians’ outrage is still active in Europe.

The agencies always insist that their role is not to interfere in the political process. But their actions, S&P’s in particular, are a bit disorientating. ‘Politicians’ are one of the five factors that make up their view of a country. In the document quoted above, their reservations with regards to European politics and institutions are clearly formulated. The first part of the analysis, which lead S&P to downgrade the U.S.’s triple A (August 2011), consisted also of a questionable criticism of the American institutional mechanism (the second part contained a serious error in the figures). Now the decision to downgrade France’s rating is disclosed right at the beginning of the presidential campaign, knowingly undermining the super value of the triple A somewhat naively defended by the current president and providing an opportune dialectical instrument to both the socialist candidate, pro-Europe, as well as to the candidate of the most extreme right, fervent anti-Europe. You cannot assent to the argument that an executive of the risk agency mentioned:

“there are elections everywhere at all times” (FAZ January 16)

because French presidential elections every six years are sufficiently politically important for them not to be lost in the crowd of local, regional or legislative elections. It is obvious that S&P had to have foreseen that its decision would affect the electoral program of each candidate and one wonder why it could not have waited a few months. Or is it that France’s situation is so serious as to justify the urgency? If this is the case, it is difficult to deduce it from the documentation published by the agency, especially when other agencies took advantage of the confusion to confirm their triple A.

* Luis Martí is a former director of the World Bank.