Are the credit ratings agencies suicidal?

Charles Orton-Jones’ scathing analysis of Moody’s, Standard & Poor’s and Fitch

It takes something to be disliked more than banks, but the credit ratings agencies are more than up to the job. They have a list of critics as long as your arm. They are accused of being incompetent, biased, irrelevant, destabilising and running a cartel.

Not surprising since Fitch, Standard & Poor’s and Moody’s all rated Enron as investment grade until four days before its bankruptcy – the largest in US history. The following year all three rated Worldcom investment grade, weeks before it went down in the largest bankruptcy in world history.

And then there was the sub-prime debacle. Rating worthless mortgage CDOs as AAA. Oops!

Ah, but. Are they really as bad as all that? Perhaps they just had an off day, or two, or three. Well, after researching Fitch, Standard & Poor and Moody’s for a week or two I can say, hand on heart, the Big Three ratings agencies deserve their bad press. And then some.

Here’s why.

The rating agencies don’t seem to know what they are doing

Let me pose a simple question to you: who pays for rating the creditworthiness of sovereign nations such as the UK and US?

Most people guess that it’s the nation that pays. But that ain’t entirely so.

Sometimes the nation will refuse to pay, so the ratings agencies go ahead anyway and write unsolicited ratings to sell to investors. The question of which nations are paying, and which are not, is pretty vital, in part because there is a raging debate over whether the ratings agencies are incentivised to provide better ratings to please their paying customers.

So which nations pay?

To get an accurate list I called the press offices of all three and asked which sovereigns pay and which don’t.

The press officer for Fitch, Peter Fitzpatrick, said: “We don’t know”. Seriously! They don’t have a list of which nations pay them and which do not, and finding out was apparently beyond the call of duty. So I asked whether he knew if the UK pays for its rating. Answer: No one at press office knows and cannot find out. Not encouraging.

I then tried Moody’s press office. I asked them who pays for Moody’s sovereign reports. “Moody’s operates on an issuer pays model,” said their press officer Jessica. Hmm. This contradicts what Moody’s told the House of Lords sub-committee investigation into ratings agencies last year: “MIS operates under an issuer-pays business model, meaning that an issuer pays for MIS to assign a rating to it or to its debt. In some cases, sovereign issuers do not pay for a rating and MIS therefore receives no revenue for issuing the credit rating.” When I put this contradiction to the press office they went into a panic, and refused to talk to me on the phone. Bonkers.

Only S&P could provide a coherent answer. “15 of our 128 sovereign ratings are unsolicited. Unsolicited ratings are those credit ratings assigned at the initiative of Standard & Poor’s and not at the request of the issuer or its agents.”

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S&P provided a list of the nations that do not pay for their ratings:

• Argentina
• Australia
• Belgium
• Cambodia
• France
• Germany
• India
• Italy
• Japan
• Netherlands
• Singapore
• Switzerland
• Taiwan
• United Kingdom
• United States

S&P says the cost of a full sovereign rating report is $400.

But before I give S&P a clean bill of health on this issue I must mention that other dealings I’ve had with S&P have been pretty dire. For example, I got a call from a sales rep from S&P Capital IQ, the division that markets the ratings reports to investors. I asked whether the UK government paid for its sovereign rating and “Rajinder” confidently told me that it did – which is untrue. When I mentioned this Rajinder panicked, refused to give me his surname and hung up.

During a further conversation with an S&P rep I was told that the full UK sovereign report is available without charge for 24 hours after publication. On further pressing for details, I was told there is “no guarantee” that the report will be made available. Well, which is it?

It is not clear what a sovereign rating from a rating agency means

Okay, let’s deal with the real meat of the debate. Are the ratings useful?

Sovereign ratings are supposed to tell us the likelihood of a country honouring its debts. At least that is what the ratings agencies themselves tell us.

But there’s a problem with that.

The UK is on negative watch at Moody’s. And what are the odds on the UK defaulting? Jonathan Portes, previously top economist at the Cabinet Office and now director at the National Institute of Economic and Social Research, points out that the chance of the UK failing to do so is nil, barring  a “nuclear war or an asteroid strike”.

The UK government has a printing press, so can always churn out more cash if needed. It need never default. So the rating is obviously hinting at something else.

Perchance the rating points to macroecnomic strength? That is what Moody’s implied when it put the UK on probation, citing “materially weaker growth prospects”. This too is contradictory: as Portes points out, weak growth has been good for gilts in recent history.

Ratings don’t identify future borrowing costs. When the US got downgraded, demand for US gilts went up, lowering the cost of borrowing. Japan has been repeatedly downgraded, yet enjoys rock-bottom borrowing costs.

So what do the sovereign ratings mean?

Portes concludes: “The misdeeds and incompetence of the credit ratings agencies in the run-up to the financial crisis has been well documented. What is less well understood is that when it comes to rating sovereign debt, they simply do not know what they are talking about; worse than that, they do not even understand what their own credit ratings mean.”

Brutal stuff.

A further annoyance

In order to fathom what’s going on with sovereign ratings it would be necessary to take a look at the full reports. But journalists can’t read them. Nor can the general public. This is absurd for two reasons.

The first is that if the UK taxpayer pays for the report (which Moody’s imply is the case with them), then ordinary citizens and journalists ought to be able to see the damn things.

The second reason is that ratings agencies claim not to make money from sovereign reports. Fitch’s chief executive Paul Taylor told the Lords sub-committee: “We do not make money out of sovereign ratings – or we certainly do not make much money. I do not have the exact number, but it is probably one or two per cent of our total revenue. It is not a commercially important area just from a pure revenue and profitability point of view.” Sovereign ratings are produced not for revenue, but to benchmark other ratings.

If that is the case then why do they not publish the sovereign reports so the public can make their minds up as to whether the research is competent and relevant to the UK economy? After all, other bond issuers, such as Transport for London, publish their credit ratings in full (see here). It would show a commitment to transparency, and help the public understand how they arrive at their ratings. In or
der to combat the bad PR the agencies have accumulated it would be a real gesture in the right direction.

But no. They refuse to publish key reports. They fail to clarify what their ratings mean. And two of them can’t even supply basic information on who pays for the work they do.

The big three ratings agencies are taking a kicking from the press, from academics and even from the president of the European Commission, who says they are biased. And they act like that. They ought to be bending over backwards to court public opinion. Yet their appetite for dealing with critics and for supplying information on their activities is lamentable.

What explains this attitude to PR? Are they crazy? Lazy? Suicidal? Even the banks want to be liked. The ratings agencies just don’t seem to care.

PS: When I asked the up-and-coming US credit ratings agency Egan-Jones for information I got a detailed response within minutes. Egan-Jones says all  its reports are paid for by investors, not issuers, without exception. The average cost of an annual subscription to Egan-Jones is $28,750. The cost to an investor depends on the size of their assets under management. Reports are not sold as one-offs, only via a full annual institutional subscription.