EU Goes After Credit Rating Firms

The original idea with modern government was to provide protection for life, liberty and property. Later on, partly thanks to social conservatives, the first seeds of the welfare state were planted. Among the earliest entitlement programs were public education, retirement benefits and poverty relief. From the Preussan income-security model under Bismarck the radical left got their ideas for the first cornerstones of the modern welfare state.

Over the course of the latter half of the 20th century, governments in the industrialized world ran amok with their welfare states. As I explain in my forthcoming book “Industrial Poverty” (due out early 2014) this has now led to a situation where government is causing a new form of poverty under a depressing regime of perennial economic stagnation.

This long-term change of the role of government calls for intense debate, carefully executed research and just in general a lot of scrutiny of what government is doing to our societies, our economies – and the entire Western Civilization.

Part of that scrutiny lies in the hands of those who monitor the financial health of government. Independent credit rating institutions, such as Standard & Poor, Moody’s and Fitch, are at the forefront of this business. Their job is to inform its clients and, indirectly, the general public of how well – or how poorly – government is managing its finances.

This may seem to be a business totally unrelated to the broader change of the role of government I just discussed. However, the relation is much closer than most people think: the bigger and more economically burdensome a government becomes, the more likely it is to be a bad steward of taxpayers’ money.

On top of that, as we have seen over the past couple of years it is dramatically important that we have credit rating institutions that can tell us when a government is reaching the end of its credit line. We know from the partial Greek debt default that governments do indeed default on their debt, and that lending to them is no longer a risk-free affair. The reason for this is, again, that government has sprawled in all possible – and impossible – directions, with piles of spending commitments that it could never afford.

By constantly monitoring the finances of our governments, these credit rating institutions keep the elected officials of our modern welfare states on their toes. Our politicians should take their ratings seriously and do their best to avoid being downgraded.

Instead there have been initiatives, primarily in Europe, to discredit or legislatively intimidate the credit rating industry. This new and rather ugly trend in politics has its origin in the fact that several welfare states have lost their stellar AAA rating in recent years. Politicians who are used to being able to do essentially what the heck they want, suddenly find themselves facing an industry they have a very hard time dealing with. Like an elephant in a china shop, they continue to behave as if they were above all checks and balances. Euractiv.com reports:

The “Big Three” agencies that rate European Union government debt could be fined after failing to fix poor practices from the past, the sector’s regulator said on Monday (2 December). Credit ratings are a key part of the financial system, helping investors assess the likelihood that they will recoup their money. But the financial crisis led to unease that the market is relying to heavily upon them.

Nonsense. This was the first time governments got knocked by these rating institutions. Thin-skinned politicians who take themselves far too seriously could not live with the criticism. Instead they went after their critics. Euractiv again:

The European Securities and Markets Authority (ESMA) published results of an investigation into how Moody’s, Standard & Poor’s and Fitch compiled ratings on sovereign bonds between February and October this year. ESMA is the EU agency responsible for authorising and supervising rating agencies in EU countries, some of which have objected strongly to their ratings by agencies.

Let’s note that the regulator of credit rating here is the same entity whose credit will then be rated. Imagine if we individuals could determine how Equifax, TransUnion etc rate our credit…

Sovereign ratings became politically charged at the height of the euro zone crisis when S&P infuriated Greece in 2011 by cutting the rating of its debt while the country’s EU bailout was being renegotiated. This led to the third of three EU laws to regulate rating agencies in as many years. From next month, the agencies can only release changes to sovereign ratings according to a pre-set calendar to improve transparency.

There is nothing wrong with how S&P handled the Greek situation. The bailout did not solve the crisis; it did nothing to alter the course of the crisis and only served the purpose of prolonging an already unsustainable situation. To use that as a reason for regulatory changes to the ratings industry is to go after the kid who points our that the emperor has no clothes.

“ESMA’s investigation revealed shortcomings in the sovereign ratings process which could pose risks to the quality, independence and integrity of the ratings and of the rating process,” ESMA Chairman Steven Maijoor told reporters. “They should speed up their processes and make sure they get their house in order.”

What shortcomings? More than likely, this is bureaucrat-speak for changes to what these rating institutions can and cannot say, with the explicit purpose to make sure government can continue to borrow money without risking credit downgrades. This would correlate well with some of the Basel III regulations that the world’s welfare states have imposed on the financial industry.