Budget monitors are a discredited bunch

They were discredited during the sub-prime mortgage crisis in the US and the financial shenanigans that followed around the globe. But the buggers will be watching what the Government does on Budget Day, their calculators at the ready and their pencils sharpened to tick down our credit rating if they don’t like what they see.

Alf refers to the credit rating agencies that wield huge power in the domain of international finance.

The Herald tells us today:

The Government needs to get its books out of the red within five years, says one of the three men who will decide after Thursday’s Budget whether New Zealand’s international credit rating will be downgraded.

The Treasury has told Finance Minister Bill English that with no changes to spending policy, New Zealand would have recurring operating deficits of more than $10 billion a year and borrowing would be about $135 billion by 2023.

Standard & Poor’s analyst Kyran Curry said the group was looking for New Zealand to reach a stable position soon.

He is one of three S&P executives in New Zealand this week to decide whether to take the country’s AA+ rating off negative watch and back to stable or to downgrade it.

A downgrade would increase the cost of international borrowing.


Alas, we must pay heed to Curry’s opinions. A downgrade could add $600 million to Government debt interest costs, Secretary to the Treasury John Whitehead pointed out the other day.

But having to kow-tow to the buggers gives Alf a serious dose of the shits.

They played a big role in landing the world economy in its present mess.

In April last year, A Guardian rundown of the world’s financial troubles mentioned an IMF report which set out a range of options for easing the credit squeeze. They included firmer regulation of credit rating agencies.

Two months later, Reuters reported from Brussels:

Credit rating agencies will face mandatory new European Union regulation, EU Internal Market Commissioner Charlie McCreevy said on Monday, following criticism of their role in the U.S. subprime crisis.

The new rules would affect agencies including Moody’s (MCO.N), Standard & Poor’s (MHP.N) and Fitch (LBCP.PA), which dominate the hitherto lightly regulated sector.

McCreevy said in a speech, prepared for delivery in Dublin and made available in Brussels, that self-regulation had proved insufficient, calling their voluntary code of conduct “a toothless wonder”.

A Sri Lankan banker, Nihal Welikala, a former CEO of NDB Bank and Citibank, wrote about the banking sector, its role in the economy and events that culminated in the credit squeeze and recession.

The responsibility for credit worthiness was in effect passed on to a handful of credit rating agencies on the basis of whose unrealistically optimistic ratings, investors across the world scrambled to buy these securities, without much appreciation of the risks they were taking.

Kevin Hall, writing for McClatchy Newspapers, said the system broke down when mortgages were being bundled and sold to investors.

Investors relied on credit rating agencies like Moody’s, Fitch and Standard & Poors, which gave the prestigious AAA rating to many of the mortgage bonds.

But the rating agencies had a conflict of interest. One branch of their business worked with investment banks to pool and package the bonds while another arm rated them.

Only in mid-2007 did the Securities and Exchange Commission (SEC), which regulates the stock market, obtain the powers to regulate the rating agencies.

An Australian commentator, John Quiggin, more forcefully wrote:

The present financial crisis is notable for the lack of high-profile villains upon whom blame can be pinned.

There is no obvious Enron or Long Term Capital Management. Rather, the entire financial system has failed, and the checks and balances that were supposed to prevent such failure have proved useless.

Among the most prominent checks and balances are private sector ratings agencies, of which the most prominent are Moody’s, Standard & Poor’s, and Fitch. Although these agencies claim only to offer opinions, and therefore to fall under the protection of the First Amendment to the US constitution, they have long-held quasi-official status.

All sorts of bodies, such as local councils, are required by law, in Australia and other countries, to invest only in assets rated as AAA (or sometimes as A or above) by these agencies. In effect, we have outsourced a large part of our financial regulation to foreign companies that offer no guarantee of their own reliability.

As councils in Australia, and many others investors have found, relying on a AAA rating can be a road to disaster. For example, Wingecarribee Shire Council in New South Wales, operating under rules that specifically enshrined Moody’s and Standard & Poor’s ratings, invested in AAA-rated collateralized deposit obligations sold by Lehman Brothers. The investments were worthless, and the Council’s attempts to recover its money seem doomed, now that Lehmans itself is bankrupt. Thousands of AAA-rated investments and tens of thousands of investors have experienced similar outcomes.

Quiggin said there were several explanations for the failure of the ratings agencies.

First, like most participants in global financial markets, they have shown themselves to be subject to the euphoria that is associated with a booming market, and the prosperity it brings to the financial sector.

Second, they are subject to inherent conflicts of interest, since the issuers of financial securities pay to have them rated.

Third, and most importantly, they have a long-standing ideological bias against the public sector. This is reflected in the fact that state and local governments, which rarely default on their debt, are assessed far more stringently than corporate issuers.

In the last year, thousands of private-sector securities issued with AAA ratings have been downgraded to junk, and many have subsequently gone into default.

By contrast, defaults on government debt have remained rare. One effect of the differential ratings practices of the agencies is that government borrowers have been forced to seek insurance from bond insurance companies such as AMBAC that are, in reality, less sound than the governments they are insuring.

Yeah, he sounds like a bloody lefty. But that doesn’t flaw his analysis or undermine his facts.

The credit rating agencies have a lot to answer for.

Having the buggers constrain what Bill English can do on Thursday is a bit bloody rich. But it’s a grim reality, too, as those budget deficits balloon.

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