The American Credit Rating Agencies are in Trouble in Italy: is it the Beginning of the End?

English: A logo of the Standard & Poor's AA- r...Image via Wikipedia
The American credit rating agencies are often seen as the villains of the financial world, particularly by governments whose debt is downgraded. The credit rating agencies  have held hostage the Euro-zone governments, starting first with Greece and moving on steadily through the Euro-zone until France was knocked off its triple A on January 13, together with Italy and a number of other Euro-zone countries, sparing only the Netherlands, Belgium, Luxemburg and of course Germany. But Germany for the first time got a negative outlook to it's Triple A - suggesting that with any downturn in the European economic outlook, even Germany risked its Triple A. 

Then on 16 January S&P downgraded the European Bailout Fund (the EFSF - European Financial Stability Facility) because it is backed by downgraded countries, chief among them France...In practice, this does not affect the EFSF lending capacity of €440 million that is in place until the European Stability Mechanism becomes operational in July 2012, but it certainly doesn't help. It has all the look of a quite unnecessary move on the part of S&P.

Europeans are becoming restless and even the German Foreign Affairs Minister, Guido Westerwelle, muttered on his way to Greece that a European Rating Agency should be created. "The time has come for Europe to prove that it can resist credit rating agencies" he told the press.  

But the Italians are not waiting for any new agency to be formed. According to the Italian newspaper Repubblica (reported in 20 January edition ), the Procura (Public Prosecutor's Office) of the cities of Trani and Milan launched an investigation on 16 January and the Italian Finance Police - the Guardia di Finanza - struck, raiding the Milan office of Standard & Poor's, taking away computers and email exchanges. In addition, the Consob (the Italian equivalent of the Securities and Exchange Commission) has issued a warning to both agencies, S & P and Moody's, inviting them to "adjust their procedures" as they are "not in line" with European Union guidelines (see news on site).
English: Guardia di Finanza (Italian finance p...Image via Wikipedia

So far it seems that seven persons are under investigation: three analysts from S&P, one from Moody's and three directors from both agencies, all accused of having spread in May, June and July 2011, news that were "not correct and in any case false and tendentious regarding the strength of the Italian economic-financial and banking system". To this was added the "episode" of Friday 13 January: the unexpected bump faced by the Italian bond auction that morning. 

In some ways, what happened that day could have become much worse if the markets had not already discounted to a large extent the downgrading of Italy's debt. Nonetheless, the bond auction that morning was not covered by bids to the expected extent, and the infamous "spread" (difference) between the Italian and German bond prices rose once again, reaching the danger zone of 500 base points - and this in spite of the fact that Italy had taken all the required measures to face the Euro crisis and satisfy investors. 

This odd behavior found an explanation by 4 pm that day, when rumors widely circulated that France and Italy were about to be downgraded that very evening by S&P. Blame was laid by the Trani Prosecutor at the doorstep of S&P.

Why all the legal fuss? First, because by law, Standard & Poor's is supposed to inform the concerned authorities of its downgrade before anyone else and certainly before the markets, yet somehow the news had spread earlier...

Add to that the fact that the downgrade of Italy was universally perceived as excessive, even wrong in the face of Monti's government efforts and highly praised austerity and growth measures: Italy was downgraded by two steps and not one, from A to BBB+.

Do the Italians have a case against the rating agencies? The agencies, as might be expected, loudly claim their innocence. But the Trani Prosecutor and his office have prepared their case very carefully, pooling expert opinions from respected economists as well as from personalities in the world of finance and banking, including testimonies from ex-Prime Minister and European Commissioner  Romano Prodi, Mario Draghi, the new head of the European Central Bank and Giulio Tremonti, the Finance Minister in Berlusconi's last government and Torino University Professor. 

So it's their word against the agencie's. Moreover, the numerous linkages between the rating agencies and banks who are their customers (in particular Goldman Sachs, JP Morgan and Morgan Stanley) and investment and hedge funds such as Black Rock, State Street, Capital World Investors, Vanguard, Fidelity etc have become the subject of striking diagrams in Italian newspapers and elsewhere, where the lines cross each other, embedding the agencies in a spider network...

That is probably the most dangerous aspect of this story for credit rating agencies: their unhealthy relationships with the world of banking and investment - their natural customers - are at last revealed to public opinion, voiding their claim of independence and transparency.

What is needed is a truly independent rating agency...As Chakrabortty of the UK Guardian observed (see article below), "the agencies are neither accurate nor merely observers - yet they bully governments around the world and make billions doing so. The obvious solution would be to take this public service into public hands. Let's have a ratings agency run by the UN, funded by pooled contributions from both lenders and borrowers. It should be the only one to have preferential access to data from corporates and countries. Let's make the ratings business a utility rather than a semi-cartel that intimidates elected politicians and rakes in excess profits. It's time to break up the bullying double act."

Strong words...with which I fully agree. Because unfortunately one cannot do without credit rating agencies: any borrower, whether corporate or government, that needs to go to the bond market needs a credit rating report to show investors. It's a necessary function, but it need not be in private hands that twist it to their own advantage...

English: World countries by Standard & Poor's ...S&P's World: Green = AAA; Turquoise = AA; Blue = BBB...Image via Wikipedia

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