Europe Berates Raters

The three big credit agencies are facing a chorus of complaints from Europe. European leaders say the agencies undermined their attempts to stop the sovereign debt crisis from spreading deeper throughout the so-called euro-zone. That is because in recent days the agencies have downgraded Greek, Portuguese and Irish debt to junk status. Each downgrade makes it more costly for those countries to borrow money.

For Europe, it has been a bit like being stuck on a carrousel: The agencies downgrade a member state’s debt, driving up interest rates. That country goes deeper in the hole. The agencies downgrade again. Round and round it goes, with the country getting sicker and sicker. Speaking last week, European Union’s Commissioner for Internal Markets, Michel Barnier, said enough is enough.

“I personally don’t think you can give a rating to a country,” he said, “like you can give a rating to a product or a company.”

Yet that’s exactly what Standard & Poors, Moodys and Fitch do. They rate companies’ and governments’ ability to pay back borrowed money. And they are not going away. On national TV Sunday in Berlin, German Chancellor Angela Merkel suggested a possible end-around: give the U.S. based agencies a little competition.

“I think in the medium term it’s important for Europe to have its own rating agency,” Merkel said. “Of course we, as the state, cannot simply create a ratings agency because that would look like we’re creating our own ratings.”

So how would a European ratings agency work? Markus Krall is with the consulting firm Roland Berger. He told Al-Jazeera that unlike the U.S. agencies, Europe would create an institution free from conflicts of interest.

“For one, it will be a non-profit private foundation,” he said. “So the ‘incentivisation’ of the rating agency will not be profit.”

Traditional agency profits, critics point out, come from fees paid by the same banks and multi-nationals that the agencies are supposed to rate. They cite the case of Lehmann Brothers to show how the agencies have appeared reluctant to bite the hand that feeds them. In 2008 Lehmann received a favorable rating – the day the bank collapsed, sparking the global financial crisis.

But Barcelona economist Eduardo Martinez of the IESE Business School said that before adding any new agencies to the mix, the existing ones must be forced to change. He said he worried about their lack of transparency. He said there is currently no way for governments to predict whether an agency is going to upgrade or downgrade its debt, because the agencies don’t make their grading criteria public.

“If I go to take an exam, I know the grade that I will get if I get all the questions right,” he said. “Not the case with S&P, Moodys, Fitch. You don’t know. At the end of the day, there is a subjective judgment.”

A subjective judgment that can send a nation’s finances into a tailspin. The EU’s proposed new agency would be structured to avoid such tailspins. Instead of rating individual governments, goes one idea, it would evaluate the 17 member euro-zone as a whole. But Martinez, like many investors, rejected that idea.

“I’m lending money to the Greek government,” he said. “I want to be sure the Greek government is going to pay me back.”

Martinez said he thinks Moodys, Fitch and Standard & Poors will resist any attempts to change how they work. But unless something changes, CEOs and government officials will be at their mercy.