Who rates the raters ?

By Dominic Rushe guardian.co.uk

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How do you rate the ratings agencies?

Their AAA ratings of dodgy securities helped create the financial crisis. Now, they're deciding the fate of nations. What a racket

Leading credit rating agency Standard & Poor's headquarters in New York. Photograph: Kurt Brady/Alamy
Remember when your mum told you to stand up to bullies. Not always a good idea, it seems. With economies across Europe now facing meltdown, the credit rating agencies that did so much to help them get into this mess have, according to Reuters, warned the European Commission they may stop rating risky countries. Why? Because the EU has had the temerity to suggest they should be legally liable if their ratings prove to be wrong. This threat, which would leave weaker European countries struggling to raise cash, comes amid an escalating battle between European officials and the ratings agencies. But it could also mark a turning point for the credit agencies – still under fire for their role in the credit crisis, a moment when these behemoths may finally be called to account. Relations between the three main credit agencies and the EU hit a new low this week after Standard & Poor's downgraded Portugal and demoted Greece's credit status to below that of Egypt. Not so long ago, credit rating was a staid and not terrible interesting business – few cared what they thought of Greek bonds or Portuguese debt. It wasn't until the 1990s that the agencies started to rule the world. Riding on the back of globalisation and technology, the two grand forces of our age, credit agencies managed to establish themselves as the dominant independent arbiters of risk. Today, the market is dominated by Moody's and Standard & Poor's, with Fitch running third. The big three rate everything from corporate debt to pension funds to countries – and everybody listens. It's also big business: if you want a good loan, you need a good rating. Last year, Moody's sales topped $2bn. But as their business and influence have grown ever larger, more people are starting to ask who rates the raters? As the Greeks and Portuguese will testify, their influence is enormous. Far larger economies than theirs have been battered by the ratings agencies. In 2000, Moody's took on Japan, downgrading its credit and causing an international incident as the cost of borrowing in Japan shot up. Moody's concluded that the pace of economic reform was not going quickly enough in Japan. As it considered another downgrade in 2002, the Financial Times pointed out that Japan would soon be rated lower than Botswana, a country where "a third of the population is infected with HIV/Aids". Japan is still on watch, with more downgrades threatened. But where would you rather put your money, really? Time and again, the agencies have got it horribly wrong. They promoted Enron even as its management blew the company up; they promoted the subprime mortgage market as its foundations collapsed – and took the financial markets down with it. In the US, states and investors are lining up to sue over their role in the financial collapse, arguing these fools couldn't pass a pig without putting lipstick on it. This poses a big question: do they know what they are doing, or they are more interested in profits than making accurate forecasts? Former members of staff seem to think it's the latter. In testimony to the US Financial Crisis Inquiry Commission, former Moody's analyst Mark Froeba said the firm's management "used intimidation to create a docile population of analysts afraid to upset investment bankers and ready to cooperate to the maximum extent possible." Froeba left Moody's after 10 years' employment, in 2007. All this is not to say that there aren't real structural problems in Greece, Portugal, Japan, Ireland or the UK, for that matter. Moody's has even said it might downgrade the US, if it doesn't get its fiscal house in order. But where were the agencies in the runup to this fiasco? Nowhere to be seen. Are they selling accurate information or "a feeling of confidence in the future", as Warwick University credit agency expert Timothy J Sinclair has it. When they were minor players, it wasn't a big issue, but now unelected executives with, at best, a spotty track record are shaping the future of nations, sailing through storms which they helped to create on the way to ever greater profits. Those who have the temerity to stand up to them better watch out. But if you were going to rate the raters, they would have to get an F.