The ratings agencies are the bookmakers of the financial world. Their job is to make accurate, dispassionate appraisals of the risks associated with bond issues and the financial health (credit worthiness) of businesses. Latterly, they’ve been much in the news for their prognostications over the sovereign debt crisis afflicting Greece, Ireland, Portugal, Italy and Spain. When the ratings agencies downgrade a credit rating, what they are saying is that the venture in question is less of a dead-cert than it was. Ratings is a subjective game and even an institution with a “junk” status to its credit worthiness is not certain to fail and go into a default, of course.
The credit ratings agencies are largely supposed to be looking at the particular set of circumstances which affect the company they are evaluating. For this reason, it might come as a surprise to learn that one of the biggest ratings agencies, Moody’s, has downgraded the ratings of twelve British financial institutions (banks and building societies) because they think that the UK government is less likely to bail them out in the event of a further crisis. This is absurd. The credit worthiness of these financial houses surely has nothing (or perhaps I ought to say should have nothing) to do with the willingness of a government to bail things out in the event of a wheel coming off.
Whilst they were about it, Moody’s also downgraded nine financial institutes in Portugal for similar reasons.
Moody’s was at pains to point out that the move did not “reflect a deterioration in the financial strength of the banking system”; er, right. The move caused a fall in the stock values of the banks involved. It seems to have been anticipated by the financial sector and the UK Chancellor of the Exchequer, George Osborne, commented that one reason for the downgrades was that the government was seen to be “trying to deal with the too-big-to-fail problem”. This was an allusion to the problem facing many nations when the financial crisis first hit. Bad debts, in the shape of sub-prime mortgages, threatened to collapse a number of major financial houses unless governments stepped in to underwrite them. This lead to a burgeoning of public sector debt (which had been high in the first place), ultimately leading to the ratings agencies downgrading sovereign debt credit ratings in several countries and forcing up the cost of borrowing.