Rating agencies, where did they get their power from?

Discussion in 'Economics' started by Debaser82, May 23, 2011.

  1. When did countries decide rating agencies such as Finch and S&P get to rate countries and companies worldwide?

    Why are other rating agencies doomed to remain obscure?

    Could they in theory be shut down, or lose their privileged position?

    Why would politicians continue to accept their interference?
  2. LeeD


    You are forgetting about Moodys.

    From wikipedia article:

    "Regulators use credit ratings as well, or permit ratings to be used for regulatory purposes. For example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking regulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs", or "External Credit Assessment Institutions") when calculating their net capital reserve requirements. In the United States, the Securities and Exchange Commission (SEC) permits investment banks and broker-dealers to use credit ratings from "Nationally Recognized Statistical Rating Organizations" (NRSRO) for similar purposes. The idea is that banks and other financial institutions should not need keep in reserve the same amount of capital to protect the institution against (for example) a run on the bank, if the financial institution is heavily invested in highly liquid and very "safe" securities (such as U.S. government bonds or short-term commercial paper from very stable companies)."

    "SEC regulations also require that money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but without Federal Deposit Insurance Corporation insurance) comprise only securities with a very high NRSRO rating. Likewise, insurance regulators use credit ratings to ascertain the strength of the reserves held by insurance companies."

    "According to professor Frank Partnoy, the regulation of CRAs by the Securities and Exchange Commission (SEC) and the FED has eliminated competition between CRAs and practically forced market participants to use the services of the three big agencies, Standard and Poor's, Moody's and Fitch."

    On a side note, Frank Partnoy's F.I.A.S.C.O. is a highly entertaining read.
  3. I read that, and it explains why it can rate companies in the US but does not explain why it has power to rate countries I would think or does it?
  4. LeeD


    The above quotes explain why credit ratings are so powerful.

    However, rating agencies do not have a "power" to rate any company (or country). If a company (or country) wants to get rated, they ask a rating agency for a rating and pay a fee. If they want for a rating agency to keep the rating up-to-date (by periodically re-evaluating credit risk and providing upgrades/downgrades when due), they specifically request this from the rating agency and pay a larger fee.

    To summarise: rating agencies only rate companies or countries who voluntarily request to be rated. However, companies or countries officials may feel compelled to obtain a credit rating as government regulations worldwide severily restrict investments by regulated institutions (banks, mutual funds, insurance companies and others) in unrated bonds.

    P.S. Basel II requires banks to rate bonds in-house, which reduces the reliance of European and Australian banks on credit rating agencies.

  5. So basically it is a political decision, that could be turned around if desired.

    Thanks for the feedback, yet it leaves open the question why these 3 have basically managed to form a monopoly and if the existence of these agencies requires US government approval how is independancy guaranteed?

    The latter ofcourse is an unavoidable obstacle given how no matter where they would be located the suggestion of leniency towards the location's country would always be around.
  6. LeeD


  7. Read an article on this idea back in a college sociology course.

    The power of large numbers:
    If many people believe in an idea, even if it is false, then it is real in its consequences.

    Remember the salem witch trials? Everybody believed in witches therefore the consequences were real. They killed witches.

    Rating agencies? Everybody looks at their reports therefore they are real in their consequences.

    Act accordingly.
  8. Credit in itself is a failure.