Rating Italy (and others)

Contributors to this corner have often taken issue with the performance of rating agencies. For instance, Pablo Pardo posted an interesting column a few days ago. Fitch’s move on Italy on March 9 provides a fresh incentive to look again into this subject.

Rating agencies have often targeted Italy in the recent past. The main three agencies reviewed Italy three times (unsolicited) in the past fourteen months. S&P’s downgraded  the country to a triple B+ with negative outlook (January 2012). Moody’s rating edged it down to Baa2 (July 2012) with negative outlook, and Fitch joins now (March 2013) the gang with an A- rating and negative outlook. These are the bare facts.

S&P’s review in January 2012 highlighted the rising financing costs faced by the Italian Treasury. True, and fully understandable. Markets had perhaps not been totally indifferent to S&P’s latest downgrade of Italy just three months earlier.  The agency then put to good use this information as a justification for a pretty gloomy forecast: unfavourable market conditions were bound to force the Italian Treasury “ ….(to) pay historically high yields…”  In troubled times, pessimistic views sell well and sound like a safe bet, but you can get it all wrong anyway. In fact, six months later, Italian yields changed course and the Treasury faced much friendlier markets.

Moody’s expressed concern over the soaring yields of Italian debt and also predicted that the Italian Treasury would find no easy way out. The option would be either “a further sharp increase in funding costs or the loss of market access.” The agency reminded investors that this was due to “increasingly fragile market confidence.” Not bad. As in the previous example, lower ratings undermined market confidence, and now weak market conditions are displayed as a major cause of your own lack of confidence. Looping the loop, as in aviation acrobatics. Just a couple of weeks later, the European Central Bank managed to calm down the waters and, at the very least, pushed back that ominous option.

Now Fitch steps in. The current scenario shows calmed waters. The 10-year Italian bond had been trading at around 4.62 before the downgrade became news, and was trading marginally above that, around 4.66, a few days later. This time the justification could not rely on unruly markets, so Fitch thought it best to dwell on the dubious capability of the Italian institutional arrangements to set right the mess left by the electoral results of February 24. Well, maybe. Italy, and many of our countries as well, could do with a thorough redesign of some features of our political systems, but I do not think we are looking to credit rating agencies to show us the way. In fact, the Italian institutions have often dealt, in their way, more or less effectively, with the imbroglio of their multi-party system without drawing the interest of rating agencies. Why do they now assume a censorious role toward democratic institutions? S&P’s also volunteered some lessons to the US political establishment on the occasion of their August 2011 downgrade (Moody’s and Fitch left it at a change of perspective to negative).

Thus, we find agencies whose economic reports often build on their own record–our last review left markets nervous, and nervous markets prompt us to downgrade again–, work on inaccurate or incomplete  scenarios–passing over, for example, the ability of European institutions to come to positive action–, or fully take up political analysis–casting doubts, for example, on the resilience of long-established democratic structures.

Markets, however, seem now to respond with less automatism to the ups and downs in the ratings. It is as though a subtle change of perception were emerging. No knee-jerk reactions, as so often was the case. As Bloomberg put it on March 9, “investors are paying less attention to the views of rating companies, relying more on their own analysis…” And their own analysis, adds Bloomberg, does not lead to indecision, or to some kind of wait-and-see attitude: it  often indicates nonconformity with the rating practice and its underlying justifications. Yields on sovereign debt ran counter to rating reviews in over 50% of 32 reviews: this certainly looks like an important finding, which–lacking access to their methodology–I must take on Bloomberg’s credit.