The news that the U.S. Justice Department has filed civil fraud charges against the largest credit ratings agency, Standard & Poor’s, for behavior that it alleges contributed to the cataclysmic financial crisis will be cheered by millions who have suffered from the subprime mortgage disaster.
But will a lawsuit, successful or not, help correct the problems of the major ratings agencies that have failed to pass the test of professional credibility, upon which senior members of the financial sector on Wall Street relied?
While many people in the financial sector were blinded by greed to the need for deeper analysis and due diligence on what were later exposed as unworthy credit instruments, there remains a potentially more destructive role these agencies play: the rating of sovereign debt. Imagine the domino effect of a sovereign debt downgrade forcing governments, many already beleaguered by servicing public debt, to impose further hardship on a citizenry because of some faceless unaccountable number-crunchers within a ratings agency — people who are removed from the real world that they assess.
When the United States was downgraded in 2011, Treasury Secretary Timothy F. Geithner declared that the ratings agency showed “really terrible judgment” and a “stunning lack of knowledge about basic U.S. fiscal budget math,” adding that “they drew exactly the wrong conclusion.”
Falling interest rates in European countries like Italy and Spain suggest that lenders may have become skeptical about the presumed wisdom of the ratings agencies. How could they not, given the central role these agencies played in the financial crisis, sometimes offering investors a triple-A rating on what was essentially financial garbage?
There are many villains besides ratings agencies in this tragedy, which has cost millions of people their homes and financial security, yet few of the perpetrators have paid any tangible price. In the words of the journalist and economist Anatole Kaletsky: “The economics profession must bear a lot of the blame for the current crisis. If it is to become useful again it must undergo an intellectual revolution — becoming both broader and more modest.”
Whatever the outcome of possible lawsuits against the private ratings agencies, surely there is an inescapable conclusion: They cannot and must not be relied upon to assess the capacity of sovereign states to meet their obligations.
They will undoubtedly continue to do so, but their credibility has been impaired to the point where there must be an alternative. What could it be? An intergovernmental capacity to rate sovereign debt. Is that possible?
An example is the O.E.C.D. Export Credit Arrangement with a country “risk classification.” It allows the establishment of minimum premium interest rates for country credit risk. It has been widely acclaimed by participating countries, and has largely leveled the field in terms of export-credit financing, where for many years the financing facility offered by an exporter often made an inferior product more attractive.
At present, the Export Credit Arrangement is not a substitute for sovereign risk classifications of the private ratings agencies, nor does it pretend to be. But it illustrates how effective and objective governments can be in assessing one another on the basis of a much broader range of social, political and economic expertise than private agencies could ever hope to acquire.
It is not a great stretch of the law nor of the imagination to foresee the creation of a truly credible sovereign debt ratings agency under the umbrella of the Organization for Economic Cooperation and Development or the International Monetary Fund, or a combination of the two. It could also be totally independent and report to the G-20.
There is such a need, and it is urgent.
Donald J. Johnston is a former secretary general of the O.E.C.D., former senior cabinet minister in Canada, and senior counsel at the Heenan Blaikie law firm.