Rating The Agencies

Sydney Morning Herald

Friday November 14, 2008

Rating the agencies

IT'S official: credit ratings agencies are to be downgraded - and not before time. It has taken a global financial crisis to force action but governments worldwide are now moving fast to ensure that tainted assessments never again imperil economic stability. Legislation introduced by the Rudd Government yesterday will go some way towards eliminating the conflicts of interest that saw triple-A ratings given to subprime junk mortgages.

The changes, recommended by the Australian Securities and Investments Commission and the federal Treasury, will require agencies such as Moody's, Standard & Poors and Fitch Ratings to obtain licences in order to function in Australia. The European Commission has agreed on its own wide-ranging reforms and this weekend's G20 summit is expected to endorse tougher regulations.

In theory, independent analysis of the financial health of companies helps markets to price risk accurately. But ratings agencies are financially dependent on the institutions they rate, and in an unregulated environment this has led to profound distortions of the real risks associated with investments. The effect of these distortions has been magnified by the huge amounts invested by pension funds and insurance companies in AAA-rated products. Local councils who put ratepayers' money into the now-defunct investment bank Lehman Brothers lost millions of dollars. A backlash has begun but the State Government seems oblivious to the trend.

Tuesday's mini-budget, framed after Standard & Poors changed its outlook for the state to negative, slashed spending and increased taxes in a bid to maintain the state's AAA credit rating. This, despite the fact that the increased cost of borrowing associated with a downgrade would be negligible. Even the country's top four banks enjoy only AA ratings, and a recent study suggested a downgrade would cost NSW only between $7 million and $14 million in increased interest payments in the initial years. The approach taken by the Premier, Nathan Rees, and his Treasurer-in-training, Eric Roozendaal, reflects not so much prudence as ignorance. An emerging consensus among financiers suggests that an undue reliance on calculating risk purely according to mathematical models contributed greatly to the present financial meltdown. Human judgment based on experience is back in vogue. By deferring to discredited rating agencies, the Rees Government is trying to outsource its responsibility for managing the state's economy. In doing so, it risks deepening an already serious economic downturn.

History records an earlier example when a similar miscalculation contributed to economic catastrophe. It was called the Great Depression of the 1930s.

© 2008 Sydney Morning Herald

Back to News Index | Back to Home