Thursday, July 26, 2007

Influence of rating agencies on international debt markets

In "The Global Credit Channel and Monetary Policy" Claus Vistesen raises the issue of the importance of credit rating agencies with respect to the effect of global financial liberalisation on the global economy.

With respect to the rating agencies, I think one of the major problems has been that investors, whether institutional or retail, have been accepting the ratings assigned to securities at face value without really digging into the guts of the ratings reports or doing much independent analysis. In the case of portfolio managers for institutions, this is really a kind of failure to perform their job.

I am sure that a conversation between a investment bank rep and an institutional buyer like the following hypothetical has happened many times:

Banker: I have X billion of automaker Y bonds available; they're going fast!

Institution: Moody's says these bonds are BAA; no problem..I'll take $100 million as fast as you can get them to me. I need the yield...

So I agree that the ratings agencies have been incentivized to shade their ratings to the optimistic side, but as always the rule of "buyer beware" applies. Buyers of issues rated by the three major raters used the reputation of the raters to cover their butts in case of default: "Well, Moody's said it was BAA!"...

With respect to the ratings agencies and sovereign debts, I am not all that sympathetic to the agencies. Both the buy-side and the investment banks wanted the agencies in place to help justify pricing of issues, and governments frequently have touted their ratings. All four groups of entities have had a stake in the system as it currently exists. If the raters downgrade a country's debt, instead of complaining about the raters, it's up to that country's policymakers to convince the market that the rating is incorrect by providing information or policy changes that demonstrate that the country's issues warrant the desired pricing.

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