"You know someone or something is in deep trouble when the search for scapegoats happens in the middle of a crisis rather than after it has ended," Mish Shedlock says in a characteristically no-holds-barred survey of the various targets in the euro-meltdown witch hunt.
The one good thing about witch hunts is that they occasionally catch guilty people. In the trans-Atlantic war on prosperity, governments have finally settled on a common enemy: the investment rating agencies that have been downgrading government debt in Europe and the United States.
Olli Rehn, European Commissioner for Economic and Financial Affairs, says the agencies were "behind the curve and reinforced the curve." That sounds a little like grabbing yourself by the hair and holding yourself at arm's length, and it's typical of the illogical complaints being made by European leaders against Fitch and Standard & Poor's for their rapid downgrading of Greece's sovereign debt.
On this side of the pond, the Securities and Exchange Commission is putting pressure on Moody's, and Sen. Al Franken (D-Minnesota) is introducing regulation of rating agencies into the stalled finance bill.
Note that the rating agencies are not getting dinged in response to their legitimate failures -- the famously too-high ratings awarded to Enron, Lehman Brothers and the universe of junk debt instruments. They're being punished for doing the right thing: sounding the alarm on Europe's manifest sovereign debt crisis and America's looming one. By coincidence, Moody's recently issued a widely publicized warning that the U.S. could be looking at a serious public debt emergency by 2013. No wonder Franken wants to rein in the raters that were considered jim-dandy back when President Obama first introduced his financial regulation bill. The agencies have gotten themselves into trouble by trespassing on government property.
Ironically, the raters have recently been making nice with government by applying a new standard for municipal debt that ups the weighting of historical performance and thus takes some of the heat off over-leveraged local governments. This is the standard Mark Twain applied to Wagner's music: "It's not as bad as it sounds." But what makes the scapegoating of the ratings agencies particularly rich is that their excessive power is itself a creation of government. The London Independent's Nihil Kumar explains:
The agencies weren't responsible for Lehman's investment decisions, nor did they pile all this debt on Greece's balance sheet. But how is it that despite being criticised in the recent past, a piece of research from one of their ilk triggers such worry in both dealing rooms and the corridors of power? The answer, many argue, is that the agencies are often backed up by the same governments they can unsettle by shuffling their ratings. In the US, New York University professor Lawrence White traces the rise of the agencies from John Moody's ratings of railroad bonds at the turn of the last century. His firm was joined by Poor's publishing company in 1916, and then the Fitch publishing company in 1924, the precursors of today's giants, with the three selling their views in thick ratings manuals.
The mid-1930s were a key marker. The US Office of the Comptroller of the Currency prohibited banks from putting money in "speculative investment securities" as determined by "recognised ratings manuals". This effectively endowed ratings with the force of law, according to Professor White. Other regulators followed suit and in the 1970s the SEC came up with a new category of nationally recognised statistical rating organisations, or NRSROs. From then on, NRSRO ratings were used to work out the capital requirements of broker-dealers, thereby entrenching the role of the agencies in the financial system.
These and other moves – in Europe today, for instance, ratings play a role within the Basel II framework of calculating capital requirements for banks – put the agencies on a "pedestal", according to Professor White. The key to curbing their influence is less, not more regulation, he says, arguing for the elimination of regulatory reliance on ratings.
The political imperative seems to be moving in the opposite direction, however. In Europe, the push is towards more rules, as opposed to removing the agencies from the regulatory system. "That is a broader debate, which we should probably have but like a lot of things, is not being pursued at the moment," says Patrick Buckingham, a regulatory partner at the law firm Herbert Smith.
"There are too few agencies in too few hands," says Michel Barnier, European Commissioner for Internal Market and Services. "We'll work with the players of the sector to increase competitiveness." That is simply not true. The plan as of now is not to increase competitiveness but to put the "few hands" under tighter control by the governments they're supposed to be rating.
Of all the reasons to disdain ratings agencies, the Western governments have managed to find the bad one. To blame short sellers or S&P or hedge fund managers or "speculators" is to condemn your only friends, the people telling you to stop gorging, now, and go on a diet. The sovereign deadbeats could have saved themselves all this tsouris by taking the advice of that great economist and monetary policy expert Kate Moss: "Nothing tastes as good as skinny feels."
