By Paramjeet Berwal
Paramjeet Berwal is a visiting lecturer at the University of Georgia.
Reuters, on March 12, reported on Standard and Poors (S&P) being sued for $150 million in Australia for systematically weakening its risk assessment criteria for giving higher ratings to debt products in order to cultivate more business by alluring product providers and the investors. The agency, allegedly, had no reasonable basis for giving higher ratings to synthetic Collateralised Debt Obligations (CDOs). The money of the investors, two local governments and two pension funds, in this case, was finally lost.
As the Australian Federal Court in Sydney will be presiding over the matter, the piece will refrain from putting forth any concrete stance against S&Ps. However, such allegations are nothing new to the financial world, where the credit ratings are highly manipulated to keep the business of credit rating agencies running. Reuters, in the same report, also pointed out that S&P had been settling its ratings-related lawsuits in the US for the last 10 years.
Shady nature of the rating market
It is pertinent to mention that a shift from the economy of manufacturing real products and services to the economy that can be characterised as dependent on merely financial speculations has led to vulnerabilities of all sorts. A peculiar feature of the financial world is that it runs, typically, on sentiments and these credit companies have been at times argued to have, without any rational reason, helped the positive sentiments take charge and cause huge leaps in financial transactions.
However, whether these financial transactions result in gains on a sustainable and long-term basis is a totally different question and can be answered in negative, keeping in mind the state of the world economy, especially since 2008.
The root cause of the problem
Unfortunately, the ‘Big Three’ (S&P, Fitch Ratings and Moodys) control 95 percent of the worlds rating market. The avenues for competition in the field are almost foreclosed. Though the idea of rating the rating agencies has been discussed before and so has been the idea of expanding the scope of competition in it, the situation is not likely to improve because the problem is not what the rating agencies do in lack of competition but why do rating agencies behave the way they do.
Therefore, instead of focusing on increasing competition in the market that is absolutely controlled by only three firms with systemic support and huge entry barriers of economic and political nature, emphasis should shift to the underlying idea of the business concept on which these rating agencies are based. In order to secure frequent good business from the rating seekers and subscribers, these companies give good ratings at the cost of investors interests.
The private nature of these agencies makes them more susceptible to profit motives for the reason that if the investments in debt products or other securities take a hit, there could still be a plethora of reasons outside the scope of the rating system followed by the agency to explain the plunge in the market.
Corrective measures
Institutionalised control over the functioning of rating agencies should be increased in order to audit their assessing methods and factor in those relevant factors that are deliberately ignored by the purely conventional economic approach. Also, the management of these rating agencies should be subjected to criminal liability if found to have manipulated the ratings.
Also, rating agencies should be made to go off the market if any violation of fair practices is detected. Settling of lawsuits outside the court shouldnt be allowed as it provides an escape route to the rating agency. These suggestions are merely an iota of reforms that should be considered to keep them in check, especially since financial transactions govern the world economy.