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Market Avenue

U.S. Debt Ceiling Debate
UPDATED: August 8, 2011 NO. 32 AUGUST 11, 2011
Angels or Demons
The roles and motives of the big three rating agencies need to be reconsidered

JOINT EFFORTS: U.S. Secretary of State Hillary Clinton and Greek Foreign Minister Stavros Lambrinidis exchange a signed document on July 17 in Athens. Clinton said the United States supports Greece's efforts to address its debt crisis (XINHUA/AFP)

When the economy goes up, rating agencies will raise the ratings. Since most debts can be paid back, high ratings cost them nothing but bring them more goodwill and profits. When the economy goes down, lower ratings will be safer, because bonds are more likely to go unpaid. If rating agencies markedly lower ratings of some companies in peril, they can also gain massive goodwill.

For example, in the current EU debt crisis, default risks in PIGS countries are obviously high. Moody's, Standard & Poor's and Fitch Ratings are repeating this commonly recognized fact in an authoritative tone, pretending to be sharp-eyed and wonderfully foresighted. Their intentions may not be to completely sink the PIGS countries and spread the debt crisis, but at least by repeating commonly recognized facts, they can raise their reputations.

Rating agencies are also weathervanes—they will swiftly readjust their ratings when the economic trend changes to go along with the situation to maintain their reputation.

Third, rating agencies are favored by the U.S. Government. In 1975, the U.S. Securities and Exchange Commission (SEC) established an access mechanism for "nationally recognized statistical rating organizations," and in the following two decades, Moody's, Standard & Poor's and Fitch Ratings gradually monopolized the rating market in the United States. Despite rating agencies' involvement in the 2001 Enron scandal—which led to the bankruptcy of U.S. energy company Enron Corp. and the collapse of auditing and accountancy firm Arthur Andersen—and the adoption of the 2006 Credit Rating Agency Reform Act, the SEC is still conspiring with the three major rating agencies and covertly maintaining a high market concentration. Because of this, people are apt to question how close the relationship between the three rating agencies and the U.S. Government is, whether there are any special purpose in the ratings of other countries and companies, and whether the U.S. Government has a hand in granting ratings.

Thorny road

Whether rating agencies are angels or demons, their part in the European debt crisis is a forewarning to the hazards of their involvement. True, the countries in crisis are debt-ridden, but when the euro zone and even private creditors are working together to rescue the PIGS, rating agencies still issue warnings for investors to look elsewhere. This is unacceptable. Encouragement should be shown toward EU officials who want to establish their own rating agencies while forcing the three rating agencies to publish their data sources and rating models.

Besides Europe, China and Russia have also established their own rating agencies—but can they challenge Moody's, Standard & Poor's and Fitch Ratings?

Alternative agencies do not have the reputations or experience of the established institutions. Older, generally means better in terms of goodwill and, more importantly, trust. Without trust, how can bond issuers be expected to believe a rating agency's data?

Also, the more impartial new rating agencies are, the more they are likely to be driven out of the market. Since bond issuers pay, they want praise, not criticism from reports. New rating agencies won't be willing to do this and will suffer from it.

Rating models and data sources are trade secrets, and when these factors are secret, people could only rely on their intuition to make judgments, so the impartiality of new rating agencies will be hard to prove. Therefore, before there is clear worldwide supervision on credit ratings, especially those of sovereign debts, the influence of Moody's, Standard & Poor's and Fitch Ratings can hardly be replaced.

Ultimately, the world needs emerging rating agencies and global supervision rules to restrain the sinister side of the big three rating agencies.

The author is an assistant research fellow with the Institute of World Economic Studies at the China Institutes of Contemporary International Relations

The Big Three

Moody's, founded in 1900 by John Moody, is headquartered in New York City and maintains a presence in 26 countries.

Standard & Poor's, headquartered in New York City, has offices in 23 countries. Its history can be traced back to 1860, with Henry Varnum Poor's publication of History of the Railroads and Canals of the United States.

Fitch Ratings was founded as the Fitch Publishing Co. in 1913 by John Knowles Fitch. Dual-headquartered in New York City and London, it has 51 offices worldwide.

(Source: the companies' official websites)

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