Thoughts on ways to improve the management of professional services firms

Saturday, January 28, 2012

How do we break free from the ratings entanglement?

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A number of people have asked to see my Australian Business Solutions January column. It's not on-line, so  is repeated below.

In December, Treasury Secretary Dr Martin Parkinson took a swipe at the global ratings agencies.

They were, he is reported to have said, “becoming mechanistic and excessively simplistic, running the risk of moving from excessive optimism to excessive pessimism every time they look at a country or firm.”

It’s worse than that. The global credit rating agencies have become a cancer eating away at the global economy, one that affects every business.

In the lead-up to the global financial crisis, they gave triple A credit ratings to institutions and securities that were clearly not. That helped fuel a global financial bubble.

As the crisis unfolded, the variations the agencies made to country and institutional rankings added to market instability.

We saw the same thing in the unfolding crisis with the Euro.

The credit rating agencies provide no new information to the market. The standard of their economic and financial analysis is clearly suspect. Yet despite all this, a shift or threat of a shift in a county’s credit rating can have damaging or even catastrophic market effects even though it tells us nothing that we didn’t already know.

It’s actually our own fault, yours and mine. Let me explain.

Our problem, and it is our problem because it affects us all, lies in the way that we awarded the ratings agencies authority without responsibility. We created the cancerous monster.

Back in a now dim and distant past when I was working in the Commonwealth Treasury, I remember discussions on the possibility that Australia might get a triple a credit rating for the first time. We did, lost it in 1986, then finally got it back in 2003.

Australia’s original concern with its credit rating at state and Federal level made a lot of sense.

In those days, both State and Federal Governments borrowed to fund infrastructure. We needed access to global capital for both private and public purposes. A high credit rating made it easier for a small relatively remote country like Australia to access funds and at a lower cost.

Sadly, from being a means to an end, the maintenance of a triple A credit rating became an end in itself. All Australian Governments preached this as a badge of honour.

Those in the business community nodded their heads and made approving noises, even though it was obvious even to Blind Freddy that much of the ratings shifts actually didn’t matter very much.

Governments throughout the world then did something worse. They built the ratings into policy, procedures and regulation. Business and especially the finance sector followed.

This institutionalisation of agency ratings, their incorporation into so many regulations and arrangements, meant that variations in credit ratings had direct flow on market effects in ways that no-one had foreseen. The ratings system itself had become a direct cause of market instability and on a large scale.

You would think that we would learn, but no! Even as Treasury Secretary Parkinson is complaining about the agencies, we see Federal Treasurer Swan, NSW Treasurer Baird, quoting rating changes approvingly as evidence of their good economic management.

Politicians respond to their electorates, that’s part of their job. But surely it’s time for the Australian business community as a whole to say enough is enough, that Australia and the world must break free from the ratings entanglement that we have created?