We have all seen them more than once these days. The weird arrangement of letters, that looks like a schoolboy was on a hyper-active learning spree: AAA, Ba3, Ca, CCC and so on. These letters are indeed a marking system, explains Rebecca Marston Business reporter at the BBC. This rating system is supposed to inform interested parties about the financial liquidity of a company or state, to give possible investors reliable information for their investment decision. In addition these letters determine also the interest rate to be applied. A change in score means a change in interest payback adds Marston. The three biggest and most influential rating agencies are: Standard & Poor’s (S&P), Moody’s Investor Service and Fitch Ratings.
I have been following these rating agencies and their estimations of states, involved in the current financial crisis, over the last couple of months. Since S&P announced this Monday, that they will re-check the financial situation of European states, and that major downgrades can be expected, as Richard Milne warns in the “Financial Times”, I´m certain this issue concerns us all more than we want. I was interested in how these agencies, that are private American business companies, are able to influence a financial crisis, that is now widening to a currency-crisis. Secondly I was curious how these rating scores come about.
The Running from Wolves – how can You achieve the Top Grade?
AAA – that´s what you want to achieve. But how do Moody´s, S&P and Fitch evaluate states and companies? Mainly they base their judgments on a range of financial and business attributes that might influence the repayment. In a statement S&B gave a long list of criteria that include: economic, regulatory and geopolitical influences, management and corporate governance attributes, and competitive position, lists Marston. She continues, that they each have 40% apiece of the business of rating major companies and countries. That means that they make very good money rating states and firms, and since the credit crisis began in 2007, they get a lot of stick for their rating methods. Richard Milne quotes in his article a London-based analyst, who said, that, “S&P appear a bit like a comic book villain. You can almost hear them shouting: ‘We will destroy you all.’”
Wolves sometimes chew Bones and sometimes States
To mention again, a downgrade of an issuers’ rating pushes down the value of a bond and raises its interest rate, which makes it even more difficult to payback the interest and the actual credit. This can cause a vicious cycle. Most countries borrow money, by issuing bonds. Now if many countries want to sell their bonds, more buyers than sellers are added to the market, what reduces the price even further, meaning an even higher interest rate must be paid. Furthermore the given ratings never seem stabile. As Marston argues in her article: One day a country’s bond is graded a safe top rating and the next, it is given a mark that suggests investors’ money is not safe.
Why are We even scared of the Big, Bad Wolf?
Besides from Moody´s, S&P and Fitch, there are various more rating agencies, but why does everyone watch these three? First of all they offer their financial information freely to interested investors (they charge the organisations, which bonds they are supposed to judge). Secondly those three are acknowledged from the Securities and Exchange Commission (US financial watchdog) as Nationally Recognized Statistical Rating Organizations (NRSRO). An evaluation from an NRSRO, makes business quicker and easier for countries and financial institutions wishing to issue bonds. But to me they often seem biased – since they´re private American companies. Marston gives an interesting example: Loads of mortgage-backed securities – the investments that were backed by loans that were either never going to be paid back or were even fraudulent – were given the very best grade by the three supposed experts in rating the likelihood of the money being paid back. How can we still value their opinion like we do, I wonder? Maybe it seems childish, but I think if we´d stop giving their ratings that much credit, I think we would overcome this financial crisis much quicker.