The credit rating agencies have got
us, coming and going. First they help cause the biggest economic calamity
since the 1930's. And now they tell us we can't take the fiscal measures
needed to get us out of this mess. Meanwhile, they are laughing all the
way to the bank (that is, if they can find one that is still solvent).
Why are we still listening to them?
The role played by the big credit rating agencies - such as Standard &
Poor's and Fitch - in the unfolding financial crisis is now well-known.
By giving complex, opaque and ultimately toxic mortgage-backed securities
high ratings and therefore, their own ringing stamp of approval, the credit
agencies enabled banks to market these destructive securities around the
world. We are now all paying the price.
Now, to prevent this very same crisis from turning into a full-blown catastrophe
1930's-style, governments around the world - from Obama to Brown to Merkel
and beyond - are finally beginning to do the right thing: they are planning
major fiscal spending operations to place a floor on the terrifying downward
economic spiral and to begin to turn the world economy toward recovery.
Even the austerity-loving IMF is strongly supporting these initiatives.
Yet now, Standard & Poor's and Fitch are sending ''credit warnings''
to other governments, threatening to downgrade their sovereign debt ratings
if they ''allow'' their fiscal deficits to increase too much. Wednesday,
Standard & Poor's downgraded Greece's sovereign credit rating. Explaining
the downgrade, Marko Mrsnik, S&P analyst, said: ''The global financial
and economic crisis has, in our opinion, exacerbated an underlying loss
of competitiveness in the Greek economy.'' (Financial Times, January 14,
2009). And in recent days, three other eurozone countries - Portugal,
Ireland and Spain - have been warned by Standard & Poor's to ''fix''
their public finances or face downgrades. Under the current system, such
downgrades would increase the cost of raising funds and be taken as a
signal to investors to shy away from these investments.
Most significantly, these public warnings fire a shot across the bow of
larger countries - such as Germany, the UK and France - that they had
better not go too far down the road of fiscal expansion, or they might
face a similar fate.
Yet, increasing spending and fiscal deficits in the short run is exactly
what these governments should be doing. And now, after helping to cause
the crisis, the credit rating agencies are blocking the way to the solution.
The actions by Standard & Poor's are therefore profoundly misguided
and potentially destructive.
For starters, the implicit model used by these agencies is fundamentally
flawed - especially in this crisis context. As even the IMF, financial
market economists, and usual deficit hawks such as Larry Summers now recognize,
as the world's economies spiral downwards, fiscal deficits will automatically
grow as tax revenues fall and spending on social safety nets increases.
This will occur with no increases in discretionary counter-cyclical fiscal
policy at all. Such depression-level deterioration surely will put pressure
on countries' abilities to service their debts and even risk widespread
defaults or debt rescheduling. The only way, then, to improve countries'
ability and willingness to service debt in the medium term is to engage
in massive fiscal expansions in the short term. But the credit rating
agency models do not reflect this truth.
This is true on a country by country case. What is most insidious about
the credit agency warnings is the ''fallacy of composition'' follies it
provokes. If collectively countries and investors follow their advice
and governments - especially in the largest countries - fail to engage
in large enough fiscal expansions - then the prospects for widespread
payment problems of sovereign debt surely will occur. A widespread heeding
of Standard & Poor's information will almost certainly lead to massive
losses for investors.
So what is to be done?
In the short run, prominent policymakers in national as well as international
forums should collectively discredit the credit rating agencies. The IMF,
the BIS, the European Union and business leaders around the world should
denounce this wrong and destructive advice. Second, the rules governing
pension funds and other investment funds should be immediately changed
- at least for the duration of the crisis - to allow them to discount
the weight they give to the agencies' ratings of sovereign debt. In the
medium term, substitutes must be found for these agencies' ratings, which
by now should have lost all credibility. The creation of a global nonprofit
agency, funded with an endowment to protect its political independence,
yet one that is transparent and broadly open to scrutiny - should be strongly
considered.
Finally, and of fundamental importance, efforts to take more internationally
coordinated action to achieve massive fiscal stimulus - supported by central
banks - must be taken immediately. This credit ratings fiasco - which
picks off the weakest countries one by one and sends warnings to the stronger
ones - an anti-Keynesian divide-and-conquer strategy - could not occur
if governments coordinated and unified their actions to turn this crisis
around.