Weekly international investment round up to March 16, 2010
In Malta we are more likely to know the energy efficiency rating of our refrigerator than the investment risk grade of our bonds but is this necessarily a bad thing?
Along with the failures of many financial institutions, credit-crazed consumers and sleeping regulators the rating agencies must also take their place in the credit crunch’s Hall of Shame but even after millions, billions and trillions have seemingly vanished the weight of their presence is still felt. The fact that their very raison d’être is to accurately gauge risk but they invariable missed the signs of the worst financial crisis since the Great Depression does little to install confidence but ironically even greater attention has recently been bestowed upon them following Greece’s disclosed economic problems along with others who may or may not face the indignity of suffering a rating agency downgrade.
Following Ireland’s loss of its ‘triple A’ status the UK has now adopted an all out trench warfare mentality in the defence of their own. But why are these ratings so important? For government bonds also known as sovereign debt a lower rating is likely to lead to higher interest rates in order to balance their perceived increased risk. For example, along with the massive dent to its reputation it is estimated that the difference between an ‘AAA’ and an ‘AA’ rating for the UK is around a half-percent or in other words higher interest rate payments equivalent to the cost of a few new hospitals.
But the acceptance of the alphabet soup of ratings is so tightly woven into the very financial fabric of many economies that the knot has become very difficult to untangle. Many companies know that without a good rating their bonds will be avoided by the public and more importantly by the huge buying institution such as Pension Fund Managers whose rules do not allow holding bonds below a certain rating.
Where competition is the very foundation of our free market system the fact that there are really only three rating agencies of any importance namely Fitch, Moody’s and Standard & Poor’s is not ideal and with their fees which can easily run into the hundreds of thousands mainly derived from those actually issuing the debt this obviously leads to accusations of conflicts of interest although this is strenuously denied by the agencies themselves as they state their value is based upon keeping their good reputation. Furthermore, they state their role is merely assessing an organisation at a particular point in time to establish the probability of a default.
Anyone who has ever sat a financial exam will be aware of the importance government recognised bodies and regulators place on credit ratings and this blind acceptance is somewhat puzzling but there would appear to be little appetite to fill the void themselves. Are ratings a good or bad thing? Is something better than nothing? Even the developers of rational thought, the ancient Greeks, would still consult their oracle with smoke, mirrors and animal bones when trying to predict the future. There are no easier answers but at least questions are now being asked.
