Politicians have pushed for an alternative to the Big Three. They could be disappointed.
European politicians have pushed for a regional alternative to Standard & Poor’s, Moody’s and Fitch for years, but especially since the Eurozone debt crisis erupted. It has become fashionable to blame the US rating firms for being overly aggressive in their downgrades of sovereign and corporate debt, with the corollary that a European alternative would have been more lenient for some reason – usually because of better information.
According to new research by academics at the University of Mainz (“A Rating Agency for Europe – A Good Idea?”), that may not be the case. In fact, the researchers consider the possibility that European raters might be more critical.
The paper gives an overview of the sources of the anger toward the US Big Three:
- Rating agencies have been showered with public anger for causing or at least amplifying the financial crisis in general and the sovereign-debt crisis in particular.
- In the wake of serial downgrades of European countries some observers suspected a conspiracy of US-based rating agencies and fretted that entire countries were helplessly at the mercy of the mischief of some private rating agency.
- Even more cool-headed observers mulled over the danger of speculative attacks and self-fulfilling prophecies triggered by hasty, uninformed rating changes.
To consider the alternative, the researchers looked to private rating firms other than the Big Three that rate European credits, specifically, Germany-based Feri EuroRating Services AG. First, they consider the three main theories regarding why rating firms often are so badly mistaken:
- Their economic and market models are inaccurate;
- They have incentives and conflicts of interest that distort their ratings;
- The Big Three oligopoly leads to collusive behavior.
These theories could have merit, but they don’t explain Feri’s behavior. According to the paper, “Feri has made larger downgrades to core members of the currency area. In general, Feri was quicker to downgrade countries from investment to speculative grade; however, it also shows a larger number of reversals. Feri appears to be less stable but also less subject to herding than the Big Three. Finally, we find that Feri tends to have a negative ‘neighborhood bias’, i.e. it was tougher on European countries than its Anglo-Saxon competitors by downgrading them more swiftly and aggressively during the crisis.”
Based on this example, politicians and regulators in the Eurozone might want to think twice about pushing for a regional alternative to the US Big Three. While it could be more accurate and less severe, there seems to be no particular reason to believe that it would have to be so.