Backlash of credit downgrade

You don’t fight City Hall and get away with it! This seemed to be the message the US government wanted to send to Standard & Poor’s after the credit rating agency downgraded US long-term debt from “AAA” to “AA+” last August 5.

From being the world’s safest investment haven, the United States was reduced to the level of a debtor whose ability to pay its financial obligations on time is in doubt.

The unprecedented lowering triggered massive selling in major stock exchanges around the world. Countries that held billions in US debt instruments expressed serious concern about the future of their holdings.

If words were sharpened knives, the verbal abuse heaped on S&P by key US political and financial leaders would have reduced it to finely chopped meat.

Two weeks later, the US Department of Justice announced that it would investigate S&P for allegedly overrating mortgage-backed securities that resulted in the 2008 financial meltdown.

Although three years have passed since that once-in-a-hundred-years crisis, the US economy remains in the doldrums. S&P’s action couldn’t have come at the worst of times.

From the American point of view, depending on their political orientation, the downgrade could either be a wakeup call or a portent of things to come.

Inquiry

When the fraudulent transactions unraveled in 2008, the US Securities and Exchange Commission led the investigation of credit rating companies that gave AAA rating to defective mortgage instruments. Except for sporadic threats of conducting its own probe for possible violation of criminal laws, the US justice department maintained a low profile on the issue.

When events in Afghanistan and elsewhere in the world pushed the financial crisis out of the headlines, it was business as usual for the credit rating companies.

By keeping below the radar and maintaining their lines of communication with the power brokers of political parties (read: continue to donate to their campaign coffers), the rating firms hardly felt a bump in their operation.

Probably not wanting to be more popish than the Pope, the US justice department went with the tide and forgot about making the rating companies accountable for their participation in the 2008 mortgage fiasco.

It kept lying dogs undisturbed until the unthinkable (at least from the point of view of issuers of US debt instruments) happened—the US lost its cachet as the world’s prime investment area, courtesy of S&P.

Objective

The motives behind the US justice department’s belated investigation of S&P for complicity in the events that led to the 2008 financial crisis raised some eyebrows.

Is the US government getting back at S&P for embarrassing it in the financial world with its downgrade? Wouldn’t its action “intimidate” other rating entities into being less forthcoming in their analysis if it would adversely affect the US economy?

But for critics of rating firms, the downgrade is a blessing in disguise. Until the rooster came home to roost, so to speak, these companies remained untouched despite damning proof of their participation in making worthless mortgage instruments look good.

The Big Three of the credit ratings industry—S&P, Moody’s Investor Service and Fitch Ratings—escaped accountability for their credit analysis by claiming they merely gave an “opinion” when they assessed the credit worthiness of issuers of equity or debt instruments, that it is up for investors to decide whether to take their evaluation into consideration in making investment decisions.

To the uninitiated, the argument looks persuasive. But the raters conveniently forgot to state that their fees for making the credit analysis depend on the rating they give to the instruments.

An “investment grade” rating translates to higher fees, and vice versa. As the saying goes, when money talks, bullshit walks.

Consequences

Regardless of the motives behind the announced probe by the US justice department of S&P, the results of its investigation will be helpful in assessing the role that rating companies should play in the capital market.

For too long, companies that want to access the capital market for their financing needs have been at the mercy of rating firms whose analysis influence the response of lenders to credit requests or the interest rates imposed on loans.

Last month, the Big Three were branded by European Union leaders as an “oligopoly” that issued self-fulfilling credit ratings on the debt papers of Greece, Ireland and Portugal, which led to the further deterioration of their already battered economies.

There are calls for the European Union to create a European credit rating agency that will service the credit needs of its members, similar to what China has put up for its investment industry.

The advantage of a criminal investigation, as against an administrative or civil probe, is it forces the people under questioning to be truthful with their statements and honest with their submission of documents, under pain of prosecution for perjury or obstruction of justice.

If all goes well, the US justice department probe into S&P will give the financial world an insight into the inner workings of ratings companies, which can guide government regulators in supervising their activities.

(For feedback, please write to <rpalabrica@inquirer. com. ph>.)