Credit Rating Agencies: the EU Targets the Messengers

The Wall Street Journal reported on P. A11 of its October 21, 2011 edition that the European Commission, the executive and administrative arm of the European Union, may ban credit ratings for the sovereign debt of EU member nations that are in bailout negotiations or receiving bailouts. In other words, the credit reporting agencies would not be allowed to issue ratings for EU sovereign debt that investors would really want to have rated.

Information is the lifeblood of the financial markets. Without adequate information, there is no rational way to price a financial instrument. The value of information is well-evidenced by the flurry of recent insider trading cases brought by the SEC and the U.S. Department of Justice. Information can be so valuable that some people will break the law to get it.

Now, the EU proposes to have investors plunk their money down for the debt of dodgy nations without knowing a crucially important piece of information--the credit rating. The credit rating agencies attained their prominent role because the financial markets are too complex, arcane and obscure for even many intelligent and diligent investors to comprehend. While these agencies have hardly covered themselves with glory in recent years, their assessments are held by many to be important (as well as being pertinent to those institutional investors that by law can hold only investments with certain ratings).

Shushing up the credit reporting agencies will have precisely the opposite effect intended by the EC. If deprived of important information, investors will become less confident, and their interest in buying or holding non-rated debt will diminish. The price of non-rated debt will likely plummet, and only vulture funds will profit. Other institutional investors and banks will take more losses than they've already sustained. The ability of the weak members of the EU to access private capital markets will evaporate, and Europe's taxpayers will be presented with more chits to pay.

That the EU wants to muzzle the messengers confirms the profound difficulties of its situation and the diminishing chances of successful resolution. Such blatant acknowledgement when the EU's leadership still claims it can wrassle this debt gator tells you that panic has set in among EU insiders. And where there's panic, bad things are likely to follow.

European Debt: Are the Rating Agencies Making Good Use of This Crisis?

Never let a good crisis go to waste, it is said. One senses that the credit rating agencies may be viewing the European debt crisis as an opportunity. They've questioned whether the "voluntary" or even voluntary reinvestment by banks and other holders of Greek debt in new long term bonds as a way of sharing losses with northern European taxpayers isn't a default. After all, it delays recovery of a good portion of the principal the bondholders would otherwise expect, and Creece's long term creditworthiness isn't self-evidently golden.

Today, Moody's downgraded Portugal's debt to junk status, finding that its chances of needing a second bailout are rising. This isn't a derivatives market domino effect. It results from an analytical process.

The credit rating agencies lost a lot of credibility during the 2007-08 financial crisis, amid allegations ranging from stupidity to blindness to conflict of interest from the fact that they are paid by issuers of securities. They've been dragged into court by angry investors, thus far surviving but hardly covering themselves with glory.

Reform of the regulation of credit rating agencies remains a work in progress. Particularly thorny are the problems of conflicts of interest and regulatory reliance on credit ratings. Resolution of these issues appears to be proceeding with all deliberate speed.

In the meantime, the agencies themselves may have figured out that demonstrating a little backbone would probably do them more good than squabbling in court or lobbying in Washington. Integrity is the scarcest thing in the financial markets--far scarcer than inside information, judging from recent government cases. Integrity's very scarcity makes it extremely valuable. The credit rating agencies' best chance for survival would come from providing accurate information and candid opinions in a timely manner. They would make themselves relevant and valuable to investors. And, at a time when virtually all high ranking governmental officials in Europe want to put new clothes on the sovereign's debt and kick the can farther down the road, the rating agencies would help move the crisis toward true resolution.

Why You Should Avoid Debt

Many voters are clamoring for the federal government to reduce its debt levels. There are a few simple, bottom-line reasons for all of us to avoid borrowing, and to pay off the debts that we have.

You can't go bankrupt if you don't have debts. You can be poor. You can have a modest lifestyle. But you won't have to plead with debt collectors, seek out credit counselors, get painful scowls at the Bank of Mom and Dad, or file for bankruptcy.

You can't lose your home if it's not mortgaged. Pay off your mortgage, and no bank will have a reason to foreclose. Whether you're gaining equity or losing it, you won't go underwater. Of course, you have to keep paying property taxes and similar assessments. But if you have the money management skills to pay off your mortgage, those other obligations will be easy.

You won't have to sweat your credit rating if you don't borrow. For obscure and arcane reasons, your credit rating can fluctuate from month to month. It won't matter if you're not trying to borrow.

You'll live better in the long run if you spend less on interest payments. Why enrich banks? Pay less interest and you'll have more money to buy stuff.

You'll have a more secure retirement with no debt. Once you're on a fixed income, debt can be a real monster. Retire your debts and your retirement will be better.

It's hard to avoid borrowing for some things. Many can afford college, cars and homes only by taking out loans. But keep the borrowing to a minimum, and pay off the loans that you have as fast as possible. You'll enjoy the peace of mind.