The financial crisis has tarnished many myths that have been presented as truths during the last decade or so – for example, lower taxes inevitably create wealth, autoregulation works, money trickles down, etc. However, many ideological and concrete elements of the international financial and economical system seem unwilling to die. The legitimacy and role enjoyed by rating agencies is one of them. My opinion on rating agencies is quite clear. The way they actually work is nonsense, hurtful and should be thrown out the window to set a new system.

What are we talking about exactly? There are only 3 major international rating agencies, all are private companies. Their role was initially to rate a business’ viability when entering the stock market to help investors and credit lenders make decisions. Starting in the 80′s, when states’ debts began representing huge financial opportunities, especially third world countries, theses agencies started rating countries as well. Now, they strongly influence the interest a country will pay to borrow on the international financial market. Let’s see what is wrong with all this.

First issue: rating agencies present their activities as simple technical-objective work while in reality they are extremely ideological in their core. For them, neoliberal economics is synonymous with economical science, leaving out a large part of economic thinking. For example, rating agencies do not accept Keynesian principles. A country trying to solve it’s problems applying Keynesian economics would therefore see its rating go down. I am not saying that they are wrong (actually, I am), but it is only my humble opinion. What is important here is that we are talking about IDEOLOGICAL positions, not technical work. Therefore, why should only one side be represented on such important issues? Especially when the ideological positions held by these agencies have proven themselves, if not always, often wrong. The 90′s and the 2001 Argentinean crisis, the highly regulated and robust banking system in Canada, and the Brazilian interventionist economical model are only a few examples of this.

Second issue: agencies do not even respect their own principles, namely competition. A few years ago (just before the international crisis broke out) I gave language classes – I will not say exactly which language, for those who know me might have a good laugh – to a few employees and directors in one of these agencies in their Buenos Aires office. It gave me the opportunity to talk with very interesting and smart individuals about their work. I pointed out to them 3 things that seemed problematic to my outsider eye:

1. An oligopoly, as there is not enough competition in a market limited to 3 companies.

2. Clear conflict of interest, as when they rate a business, guess who the client paying for the rating is – yes, that same business.

3. Considering the types of services they sell, they benefit from global economic growth, when more businesses need ratings for their investments, which translates into more business for them (and the other two agencies).

4. Little or no incentive to give bad ratings and jeopardize their own profits.

The employees basically answered my critiques with one simple and clear solution for these apparent problems: their work is based on reputation, so if they get it wrong they get discredited and lose clients. It seems very logical, but not in a 3 player worldwide market. It seemed obvious at the moment, and got even clearer when the financial crisis broke out that these structural contradictions make it impossible for the agencies to fill their role properly, which most importantly, is to give accurate information and evaluations of different actors (countries, businesses, etc.).

That’s all good, but how does it translate into the real world? The recent financial crisis has highlighted many of those problems. Agencies have given great ratings to crumbling institutions (Freddie Mac, Goldman Sachs) and have provided their “seal of approval” to many toxic financial products that accelerated the crisis. To describe the agencies responsibility in the crisis, the US Senate Investigations Subcommittee (bipartisan) said: “when sound credit ratings conflicted with collecting profitable fees, credit rating agencies chose the fees.” Basically, they got it wrong and made money out of it. Following orthodox economics, they should be castigated, run out of business … well, that’s not what happened. Market principles might apply to those being rated, especially those unable to influence the agencies –yes, I’m looking at you Greece – but they certainly do not apply to those who are doing the rating. For rating agencies, it’s still business as usual.

Finally, one could make a case about the agencies’ usefulness in rating enterprises, with some competition and more public control mind you. However, are they equipped to rate countries? Considering that financial issues cannot be isolated from their political, social and cultural contexts, how can agencies adequately rate countries? They simply do not have the expertise to do so. Cutting social services such as health care and education engenders structural consequences a lot more complex then lowering one’s deficit, which in turn affects economic capabilities in the long run. Of course, sometimes it has to be done, but rating agencies, which base their ratings on these types of measures, don’t know anything about these complex consequences and do not pretend to either.

In short, collectively we should stop giving any importance to what rating agencies say. They are in a conflict of interest, are ideologically biased, lack the expertise to rate countries and most of all, their actions hurt millions of people for the benefit of a few. Governments are forced to implement reforms to satisfy the market in the short run, even though they are doomed to fail in the long run. Argentina got out of its terrible crisis at the beginning of the century when they stopped trying to get ratings. Hopefully we can learn from history for once.

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Masthead photo courtesy of Ken Lund (apparently it’s picture of a rating agency)