Ratings Agencies – Useful?

In the last financial crisis the ratings agencies fell far short of what was expected of them and led to scepticism over their output. My own scepticism was increased when South Africa was  not downgraded at the mid 2016 reviews after their dire warnings about what would happen if growth did not improve or political instability intensified. Earlier in the year a local poll of 16 economists had almost unanimously predicted a downgrade by the end of the year. Now despite declining per capita GDP, intensified ANC government infighting and corruption extending to the highest levels of government and many government agencies, with little effort made to conceal it, there is no consensus for a downgrade. Yet various indicators, in particular those such as credit default swaps which measure market perception, are showing SA in default territory already. Nevertheless in typical ANC style (at least in the ANC’s current guise) a new BRICS rating agency is being set up on the basis that the ‘Western’ agencies are biased against developing countries (coinciding as it happens with SA giving notice of pulling out of the ICC and joining in a development bank with other BRICS partners for not dissimilar reasons). In my view this is despite the ratings agencies leaning over backwards to give time for good intentions to be put into action and despite the former frequently giving rise to incredulity. The SA Finance Minister on a roadshow with business leaders in the US to boost perceptions was charged on his return with trumped up trivial charges. This when the prosecuting authorities are desperately trying to avoid having to proceed with the over 700 far more serious charges against the president who was implicated by his good friend and sponsor, already found guilty.

More pertinently it has been argued that the ratings agencies follow rather than lead the market and in fact the agencies do base their ratings, inter alia, on economic data, which therefore to some extent validates that view. Why then continue assigning any importance to the agencies. Could it be that while they perform a useful service for investors looking at placing funds with the Microbank of Utopia they have little part to play in the very liquid international bond markets being scrutinised every minute by a whole raft of possibly more clever and qualified people ranging from Warren Buffet and Goldman Sachs down to every bank, fund manager etc. It is possible to conclude in these instances that the rating agencies are only putting their stamp on something that the market already knows and thus triggering, when appropriate, whatever conditions are set out in fund mandates. With the more esoteric investments, such as the securitisation of subprime mortgages, there could be a more useful role but then if they are not up to the task it could be argued that they contribute to the problem by creating a false sense of security. The  bosses of some of the big banks freely admit that they often don’t understand the complexities of the fancy products designed by their top maths graduates. No doubt investment fund managers also don’t but they shouldn’t be reassured by ratings agencies who also don’t but don’t have a Don’t Know rating category!


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