Advancing a Free Society

Trying to Keep Europe’s Finances Secret: Attack the Raters

Tuesday, July 12, 2011

When the news is bad, shoot at the messenger. As unwise as this strategy may be in the long run, it increasingly describes the response of the European Union’s leadership to the financial crisis that began in the periphery—Ireland, Portugal, Greece—and is now moving closer to the major economies of the center: Italy. In the wake of Moody’s downgrading its rating of Portugal, criticism has grown: not of Portugal’s finances but of the rating agencies themselves. Speaking in Paris on Monday, the European Commissioner for Internal Market and Services, Michel Barnier, questioned the appropriateness of rating agencies’ evaluating individual states that enjoy the support of the European Union. The problem in other words is the messenger, the agency that bears the bad news, and not the quality of fiscal affairs. In Barnier’s own words, “I don’t think you can rate a country which is part of a zone like the Eurozone where there is solidarity…You can’t rate a country like that as if it were on its own.” Evidently Barnier assumes that this solidarity is unlimited, even though exactly that political question is very much on the minds of voters in Germany, Finland and elsewhere in northern Europe.

Barnier’s attack on the rating agencies and their role in uncovering potential financial risks echo criticisms made earlier by Christine Lagarde, new Director of the International Monetary Fund. In addition, even the European Commissioner of Justice (who has no direct responsibility in this matter), Viviane Reding, has called for “smashing” the agencies. “I see two possible solutions: either the G-20 states agree together to smash the cartel of American rating agencies. Or independent European and Asian rating agencies are established.” She added, in an interview in the German press, that it should be impermissible for a “cartel of three American firms” to decide the fate of national economies. Presumably an agency funded by the EU will have an incentive to be as objective as the EU pays it to be.

It is in any case worth noting how parts of the European leadership are responding to the European debt crisis by conjuring up the image of an American threat. Finger pointing across the Atlantic is an easy way to shift responsibility. It hardly matters that the rating agencies are American, if the findings they report are accurate with regard to the indebtedness of European states and their credibility—and credit worthiness—in making good on their obligations. On the contrary, playing the anti-American card only diminishes the transparency that is sorely needed in order to address the fiscal challenges. More analytic heads recognize this. The chairman of the European Parliament’s Economic Affairs Committee, UK Liberal Sharon Bowles, warned against demonizing the rating agencies. “They are being shot as the bringer of bad news. I am not entirely convinced that the [rating] system is broken.” Indeed it hard to see how the reality of debt in Greece, Portugal and Italy can be ameliorated by threatening the agencies in order to scare them into silence.

Yet just such threats are in the air. Barnier has floated the idea of empowering governments to review agency data before any downgrading is announced, hardly a way to get news to the bond market in a timely fashion. In addition, the prospect of legal action is on the horizon. “European regulation could allow investors to take agencies to court when there has been negligence or violation of applicable rules…We have not closed the door to going further.” How far then will the European Union go in order to hide bad news?

It is not as if the raters have been faultless. As the chairman of the German Board of Economic Advisors, Wolfgang Franz, noted to the Frankfurt Allgemeine Zeitung,”Of course the rating agencies failed in the run up to the subprime crisis,” by being too lax in their judgments. “But then one should not complain that the agencies are pointing out heightened default risks in government borrowing.” If the international financial system needs more transparency, it will not be achieved by setting up a system designed to hide problems or to report exclusively good news, at the risk of lawsuits. And Europe won’t be able to put its fiscal house in order by blaming the United States.

(photo credit: Ma Gali)