Moody's, S&P Are Flawed Gatekeepers to Capital: Mark Gilbert
April 29 (Bloomberg) -- The stone in the shoe of the global bond market these days is when and if General Motors Corp. and Ford Motor Co. will lose investment-grade ratings at Moody's Investors Service and Standard & Poor's. The fate of about $375 billion worth of debt hangs in the balance.
Rating companies have the power of life and death over the borrowers whose debt-paying abilities they assess. Their importance is growing as regulators enshrine credit ratings in accounting and investment rules, and as the global capital markets depose banks as the primary source of lending.
In ``The New Masters of Capital: American Bond Rating Agencies and the Politics of Creditworthiness'' (Cornell University Press, 186 pages), Timothy J. Sinclair argues that there's a strong subjective element in how rating companies arrive at their conclusions, and that their perceived authority imposes a single set of business-practice standards globally.
``You could argue that by institutionalizing rating agencies, Anglo-American capitalism risks losing that wonderful capacity for creative destruction,'' Sinclair said in a telephone interview. ``Rating agencies are defenders of increasing property rights. That can become an ossification.''
Confidence Trick
Their power is a kind of confidence trick. Ratings only matter if you and I both agree that they do. Moreover, Moody's and S&P have pulled off the neat trick of appearing to be independent, impartial arbiters of creditworthiness, when they're nothing of the sort.
``People view them as important and act on the basis of that understanding -- even if it proves impossible for analysts to actually isolate the specific benefits the agencies generate for these market actors,'' writes Sinclair, who teaches international political economy at the University of Warwick in England. ``What is central to the status and consequentiality of rating agencies is what people believe about them and act on collectively, even if those beliefs are demonstrably false.''
Moody's and S&P, who dominate the world of credit ratings and ``pass judgment'' on about $30 trillion of securities, are replacing banks as the ``gatekeepers'' of who gets to borrow and who doesn't, Sinclair argues. Previously, banks stood in the middle by taking deposits and lending that money to borrowers. Both borrower and lender had a contractual relationship with the bank, rather than with each other.
Credit Guardians
The growth of the securities market is dissolving that relationship, in a process called disintermediation. ``Judgments about who receives credit and who does not are no longer centralized in banks, as was the case in the past,'' Sinclair writes. ``Over the past decade, the liberalization of financial markets has made rating increasingly important as a form of private regulation.''
This makes ratings a political issue. Rating companies influence decisions such as whether to make a new highway into a toll road. That in turn has a social impact on local residents. ``The `who gets what, when, how' questions of distribution are the sort of political questions that cannot be separated from a broader consideration of bond rating,'' Sinclair says.
It also means there's no room for alternative views about what constitutes good and bad creditworthiness. Pressure from the raters ``narrows the expectations of creditors and debtors to a shared set of norms derived from the prevailing orthodoxy about corporate governance and public policy structures,'' he says.
Opting to Default
For example, borrowers need a high credit rating to maintain access to credit lines, which in turn propagates the view that ``placing a priority on repaying debt is morally right and obligatory,'' the author says. That may not always be the best solution, though; countries such as Russia and Argentina may be better off for ignoring those strictures and choosing to default on their debts.
The prevalence of credit ratings makes it harder for borrowers to resist falling into step. ``Borrowers have a strong incentive to adopt forms of knowledge such as Generally Accepted Accounting Principles,'' Sinclair says. ``Rating agencies want comparability across countries.'' If you want access to the international capital markets, you have to play by the rules as dictated by their gatekeepers.
Moody's and S&P have a vested interest in promoting their work as independent and uncolored by subjectivity. Sinclair argues that the existence of split ratings -- where one company rates a borrower higher or lower than its peer -- shows that there's more to assessing creditworthiness than filling out a spreadsheet and cranking the handle.
Fostering a Myth
``By not making it clear that their decisions are judgments, they foster the popular myth that rating actions reflect simply the facts revealed by economic and financial analysis,'' he says. ``Consequently, they make it seem that any clear-thinking person, possessed of the right sort of knowledge, would come to the same view. Split ratings challenge the idea of a knowable rating universe that the agencies are trying to reflect in their work.''
Sinclair goes on to argue that assigning a grade is ``highly indeterminate, qualitative, and judgment laden. Rating is, first and foremost, about creating an interpretation of the world and about the routine production of practical judgments based on that interpretation.''
Sinclair says if investors had a better understanding of how ratings work, it would ``perhaps lead to a more skeptical use of rating information.''
He has something in common with other critics of the current ratings duopoly, though, including myself: He hasn't found anything to replace it with. Until someone comes up with a new way to determine creditworthiness, we're stuck with the current, flawed system. |
