Credit Rating Agencies?

What risks do rating agencies rate? For whom do they do it and based on which criteria? Who are their owners? There is a lot of controversy regarding the role they play and who they end up serving. It may be the time for establishing new rating agencies, of a very different nature than the ones existing today.

Rating agencies are private companies formed to provide risk estimates to eventual investors regarding the diverse assets in which they could invest. Later on, they expanded the reach of their evaluations covering sovereign risks (those related with the soundness or weakness of a country in terms of being able to repay its external debt). Three US companies –Moody’s, Standard & Poor’s, and Fitch—dominate as an oligopoly the market of risk estimation.

At the beginning, eventual investors paid to obtain risk estimates but, as time went by, issuers of shares, bonds, stocks and securities interested in receiving investments are the ones paying for the work of rating agencies. This generated huge conflict of interests: covert collusions arose between evaluated and evaluators as the business of rating agencies is precisely the profit they get from credit rating; their benefits as private companies depend on being hired by those who request being rated. Moreover, as their ratings impact upon the markets and the course of national economies, large areas for unscrupulous greedy financial speculation open up carried out by those favored by their decisions [1]. All this impacts on what are supposed to be the main assets of rating agencies, their credibility and professionalism that become subordinated to the eagerness to obtain as much profit as possible. Very different would be the scenario if, instead of having such a dominant position, the larger rating agencies would compete in credibility and professionalism with other regionally established rating agencies-European, Asian, African, Latin American-with better standing, much more local knowledge and subject to regulations and supervision that are inexistent today.

What is at stake is defining the type of risk being evaluated, with what purpose, based on which criteria, and for whom it is done. If only the financial risk of an investment were to be qualified without considering its systemic impact, the value for humanity of what is being produced, the collateral effects that could cause on the environment, on the concentration of wealth and the exacerbation of inequality, if the multiplying effects that investments generate and who would appropriate them were not to be considered, neither the impact on the balance of payments and the regional integration (just to mention a few of the dimensions that are ignored or marginally evaluated today), the results would be very much different from having all or most of those critical aspects factored in the evaluating process.

The situation worsens in most countries where there are legislations that require big investment funds that manage resources from pension funds, insurance companies, and affluent families to restrict themselves to invest in assets with “good” investment grade done by renown rating agencies; i.e., the three big US agencies. This way a single filter is established that qualifies which investments are good, regular, or bad in terms of criteria stemming from specific interests and ideologies presented as universal truths when they are just tough impositions to the detriment of interests and perspectives of the rest of the world.

The magnitude of the resources that way oriented is phenomenal and the kind of management used, constitute one of the main factors in generating recurrent systemic crises. The fact is that each fund is managed following the mandate to maximize profits weighted by the assumed risks which are biased and partially evaluated by the big rating agencies. This way, numerous resources are allocated just looking for profits without considering the interests and needs of entire societies. If the expected returns are not achieved, managers will lose generous success fees or are fired. Thus, the world is at the mercy of managers guided by profits and personal wellbeing, without having to assess the consequences of their actions over their society or even over the economic system that privileges them. We are dealing with trained bureaucracies encouraged to speculate that do not measure nor consider negative collateral effects of their decisions [2].

It is clear that the current rating agencies constitute an essential part of the concentrating dynamic that prevails in the world. If, instead, the evaluations were to be orientated towards identifying investments that contribute to enhance the general wellbeing, to take care of the environmental, and to ensure systemic stability, it would be indispensable and possible to replace the existent rating agencies with other type of rating entities, one that broadens the evaluation criteria to add economic, social, and environmental risks to the financial ones. It would mean moving from a rating system only dedicated to protect investor returns to another one more comprehensive that, without ignoring legitimate specific interests, would know how to subordinate them to the general wellbeing, a healthy and organic economic growth, and a sound care for the environment.

Footnotes

[1] The World Street Journal of the Americas in its February 4th, 2015 issue reports that Standard & Poor’s agreed to pay the US Justice Department and 19 States 1.5 billion dollars to close an investigation alleging that the agency deceived investors by wrongly rating mortgage bonds in the prelude of 2008 financial crisis.

[2] Is the World Burning?, Opinion Sur, Issue 113.

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