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Nuclear Ratings Agencies

by afew Thu Mar 25th, 2010 at 06:21:20 AM EST

FT.com / UK - ECB must re-examine its dependence on rating agencies

...until the end of this year, eurozone sovereign debt is eligible for the ECB's repo facility so long as it is rated at least BBB- by both S&P and Fitch, and at least Baa3 by Moody's. From the beginning of 2011, the threshold moves three notches up for all three agencies. Today, Greece is rated BBB+ by both S&P and Fitch, and A2 by Moody's. This means that if Greece is not upgraded by either S&P or Fitch before the end of this year, then Moody's - and Moody's alone - will decide whether Greek sovereign debt is eligible as collateral at the ECB. All it takes is a two-notch downgrade to bring them in line with the two other agencies and Greek sovereign debt would no longer be eligible as collateral at the ECB come 2011.

This is broadly equivalent to placing a nuclear device in the hands of Moody's because there can be little doubt that were Greece to lose eligibility at the ECB, this would imply an immediate collapse of the Greek financial system, almost certainly a sovereign default, and severe stress throughout eurozone financial markets. This is so scary - and the fact that the decision sits with Moody's makes it so unbelievable - that few people in the market think it is realistic. But how the ECB would react to a downgrade by Moody's nobody knows.

This op-ed in the Financial Times is by Erik Nielsen, Chief European Economist at... Goldman Sachs.

It's probably of secondary interest to wonder if GS would like to see the powers of the ratings agencies reduced (though one could wonder why, the current system has worked just fine for GS). More interesting, vitally so for us, is to wonder how much longer Europe is going to let Wall Street flog its craven hide?

Update [2010-3-26 2:28:37 by afew]: Jean-Claude Trichet, head of the ECB, announced yesterday that he would continue after 2010 to apply flexibility in his application of the collateral rules. In other words, that the ECB would go on taking Greek or other national bonds at lower ratings. (See, in French, Jean Quatremer's Brussels blog).


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According to FT DE, Germany is attempting to take Greece completely off the agenda of today's "summit".

See also this exchange in the Open Thread, and this highlight:

ATinNM:

I say again, the fight is about the rivalry between the US dollar and the euro.  The euro is poised to become an accepted alternative to the dollar, knocking it off from being the sole, hegemonic, currency of global trade and finance.  This fundamentally threatens the Post WW 2 status quo and those who have 'grown fat' off of the Post WW 2 status quo.
by afew (afew(a in a circle)eurotrib_dot_com) on Thu Mar 25th, 2010 at 06:28:31 AM EST
Germany is attempting to take Greece completely off the agenda of today's "summit"

According to El Pais yesterday, today's "summit" was convened by the France and the Spanish Council Presidency.

Nice little tug-of-war they have there.

Merkel keeps talking about strengthening the treaties to be able to fine countries who persistently fail to meet the GSP criteria, I suppose as long as they are not called Germany.

The brainless should not be in banking -- Willem Buiter

by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 06:52:32 AM EST
[ Parent ]
That's a key point... maybe we can start a meme around the amount Germany will have to pay in fines under the proposed rules?
by Metatone (metatone [a|t] gmail (dot) com) on Thu Mar 25th, 2010 at 06:55:01 AM EST
[ Parent ]
They wouldn't be retroactive, of course. What we need to point out is how rules don't apply to Germany, in fact they pressure the Council to relax them when they are in violation and to tighten them when others are
Eurostat's Selected Principal European Economic Indicators links to a table with annual time-series data on General government gross debt. This is Germany's:
1997 59.7
1998 60.3  
1999 60.9  
2000 59.7  
2001 58.8  
2002 60.4   
2003 63.9  
2004 65.7  
2005 68.0  
2006 67.6  
2007 65.0  
2008 65.9
In 2005, EurActiv reported:
Heads of state and government agreed at the March 2005 Summit to revise the EU's Stability and Growth Pact reform. Under the revised rules, member states must still keep their public deficits under a 3% GDP/deficit ratio and their debts under a 60% GDP/debt ratio.

However, the pact's rules have been made more 'flexible' across a range of areas. For example, member states will avoid an excessive deficit procedure (EDP) if they experience any negative growth at all (previously -2%), can draw on more "relevant factors" to avoid an EDP and will have longer deadlines if they do move into an EDP.

...

In essence, big countries such as France and Germany have won concessions making the pact more 'flexible' in various parts, adding up to a considerable relaxation of the rules. In return, countries such as Austria and Netherlands have won references to "enhanced surveillance, peer support and peer pressure".

The two thresholds - 60% for the debt and 3% for the deficit - remain unchanged.

Gee whiz, when the governments of Germany and France were about to have an "Excessive Deficit Procedure" open against them, they lobbied to change the rules. And this was in 2005, not in the middle of the biggest recession since the 1930's.
(links in the original comment)

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 06:59:40 AM EST
[ Parent ]
Another key point is that the single currency is a condition of the single market.

When the euro crumbles, and member states devalue against the DM, and start thinking in terms of national protectionist measures, what single market will there be for German exports?

The same country that pretends to tie the others down in a rigid but minimal system of rules with no fiscal or economic governance, is the one that applies globalising neolib race-to-the-bottom competition between member states.

The neolib doctrines that currently guide the EU (under Germany's aegis) are not compatible with the institutions the EU built just yesterday (under Germany's aegis).

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Mar 25th, 2010 at 09:54:30 AM EST
[ Parent ]
Another key point is that the single currency is a condition of the single market.

Bingo!

Possible to go even further.  It is the existence of the single market that verifies and supports the single currency.  The euro has value NOT from the ECB or the bits of paper and metal floating around.  No.  The euro has value because the totality and singularities of economic activity in the eurozone says it has value, backs it.  The eurozone says I can exchange euros for a packet of crisps and a hotdog -- or a multi-million euro wind power plant (if I can pony up the ante.)

The Merkel government is, essentially attacking the belief, "full faith and credit" - as it were, that the holders of euros as a reserve currency will, in the future, be able to deploy those reserves, receiving 'value-for-value' within the eurozone and/or the global financial system.  This attack on Future Value is a major cause, IMO, for the euro sinking against the dollar.  


She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Mar 25th, 2010 at 02:27:21 PM EST
[ Parent ]
And a single economic policy is a requirement for a functioning single currency area.

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 03:55:38 PM EST
[ Parent ]
As I said in the open thread:
What about lauching a "Let's rate the rating agencies" campaign like we did for StopBlair?


"Ce qui vient au monde pour ne rien troubler ne mérite ni égards ni patience." René Char
by Melanchthon on Thu Mar 25th, 2010 at 06:39:12 AM EST
Who Rates the Ratings - I like that... How many of these are around and signficant anyway?
by Nomad on Thu Mar 25th, 2010 at 09:04:55 AM EST
[ Parent ]
Even a firm like GS is not a monolithic entity. The department the Nielson sits in probably doesn't gain directly from a Greek default.

He gains by putting the prediction on the record (if it comes true) - and handily it's one of those ones which is a good bet either way. If the ECB changes the rules, he can claim influential status, if they don't and there's a downgrade then a default he can claim prescience... and if there is a downgrade and no default he can point to mitigating factors... or alternatively, you can read it as saying... if there's a downgrade and no rule change... my colleagues will make damn sure there is a default...

Finally of course, he is from Europe originally, so he may even privately quite like the idea of the euro...

by Metatone (metatone [a|t] gmail (dot) com) on Thu Mar 25th, 2010 at 06:47:48 AM EST
Some level of the financial crisis can be laid into the Basel agreements that wrote ratings agencies into the process - i.e. AAA is safe for pension funds, etc.

This ECB rule is the same mistake writ large. I understand the urge to invoke an outside agency on country ratings - it helps pretend things are "not political" - but the reality is that the ratings agencies are dominated by an ideology that is in fact very political.

Alas, the Brussels-Frankfurt Consensus is just another genetic mutation of the Washington Consensus, so the ECB is quite comfortable with the political ideology of the ratings agencies...

by Metatone (metatone [a|t] gmail (dot) com) on Thu Mar 25th, 2010 at 06:53:45 AM EST
Some level of the financial crisis can be laid into the Basel agreements that wrote ratings agencies into the process - i.e. AAA is safe for pension funds, etc.

This is because the Basel accords are a product of the (evolving) financial conventional wisdom of the last 20 years. According to Neoclassical Economics, ratings agencies make a lot of sense!

This ECB rule is the same mistake writ large.

But this is an ECB internal rule, right? Not a consequence of the treaties. What A central bank will accept as collateral at the discount window is entirely up to that central bank, and in fact that choice is a key instrument of both banking regulation and monetary policy.

Of course, this assumes the ECB is not blindly following Monetarist dogma... Oh, wait!

The brainless should not be in banking -- Willem Buiter

by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 07:02:52 AM EST
[ Parent ]
We need better bankers, both central and private. Without better bankers better banks are impossible. With better bankers better banks are not really necessary. Same with regulators. But all are probably impossible without better electorates.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Mar 25th, 2010 at 01:38:49 PM EST
[ Parent ]
I can tell you there's nothing but snickers around the table every time I attend a presentation about the Basel accords and the rating agencies come up.

For definiteness, here is the definition of a rating agency in the Basel accords: (source: Bank of International Settlements, Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version Part 2: The First Pillar - Minimum Capital Requirements

B. External credit assessment

1. The recognition process

90. National supervisors are responsible for determining whether an external credit assessment institution (ECAI) meets the criteria listed in the paragraph below. The assessments of ECAIs may be recognised on a limited basis, e.g. by type of claims or by jurisdiction. The supervisory process for recognising ECAIs should be made public to avoid unnecessary barriers to entry.  

2. Eligibility criteria

91. An ECAI must satisfy each of the following six criteria.

  • Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. Before being recognised by supervisors, an assessment methodology for each market segment, including rigorous backtesting, must have been established for at least one year and preferably three years.
  • Independence: An ECAI should be independent and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors or the shareholder structure of the assessment institution may be seen as creating a conflict of interest.
  • International access/Transparency: The individual assessments should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms. In addition, the general methodology used by the ECAI should be publicly available.
  • Disclosure: An ECAI should disclose the following information: its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, e.g. the likelihood of AA ratings becoming A over time.  
  • Resources: An ECAI should have sufficient resources to carry out high quality credit assessments. These resources should allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments should be based on methodologies combining qualitative and quantitative approaches.
  • Credibility: To some extent, credibility is derived from the criteria above. In addition, the reliance on an ECAI's external credit assessments by independent parties (investors, insurers, trading partners) is evidence of the credibility of the assessments of an ECAI. The credibility of an ECAI is also underpinned by the existence of internal procedures to prevent the misuse of confidential information. In order to be eligible for recognition, an ECAI does not have to assess firms in more than one country.
The observation is usually that no agency satisfies these conditions. So, national supervisors (that is, central banks) would be well in their rights to decree that the institutions they supervise are not required to use agency credit ratings to risk-weight their assets for regulatory capital purposes.

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 03:54:10 PM EST
[ Parent ]
I can well imagine snickers but when you come to:
Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience.

...I would expect gales of laughter. How does "validation based on historical experience" survive Q3, '08? Or is treating all of '08 as an aberration what they mean by "some form"?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Mar 26th, 2010 at 11:24:57 AM EST
[ Parent ]
Also, anyone with an ounce of statistical sense knows that an "implied probability of default" of 0.04% annually is ridiculous on its face even if allegedly estimated from historical data...

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Sat Mar 27th, 2010 at 07:29:18 AM EST
[ Parent ]
See also Luis de Sousa's diary, Missing an European Treasury.
by afew (afew(a in a circle)eurotrib_dot_com) on Thu Mar 25th, 2010 at 10:06:57 AM EST

Obama Pays More Than Buffett as U.S. Risks AAA Rating

March 22 (Bloomberg) -- The bond market is saying that it's safer to lend to Warren Buffett than Barack Obama.

Two-year notes sold by the billionaire's Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe's Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an "exceedingly rare" event in the history of the bond market.

The $2.59 trillion of Treasury Department sales since the start of 2009 have created a glut as the budget deficit swelled to a post-World War II-record 10 percent of the economy and raised concerns whether the U.S. deserves its AAA credit rating. The increased borrowing may also undermine the first-quarter rally in Treasuries as the economy improves.

"It's a slap upside the head of the government," said Mitchell Stapley, the chief fixed-income officer in Grand Rapids, Michigan, at Fifth Third Asset Management, which oversees $22 billion. "It could be the moment where hopefully you realize that risk is beginning to creep into your credit profile and the costs associated with that can be pretty scary."

Moody's Warning

While Treasuries backed by the full faith and credit of the government typically yield less than corporate debt, the relationship has flipped as Moody's Investors Service predicts the U.S. will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K. America will use about 7 percent of taxes for debt payments in 2010 and almost 11 percent in 2013, moving "substantially" closer to losing its AAA rating, Moody's said last week.

"Those economies have been caught in a crisis while they are highly leveraged," said Pierre Cailleteau, the managing director of sovereign risk at Moody's in London. "They have to make the required adjustment to stabilize markets without choking off growth."

The markets have now decided that a company regulated by a government is more likely to have money than said government, meaning that they have absolutely zero expectation that such government will ever use his sovereign powers to grab money from such corporation or otherwise hamper its activities.

It's just inconceivable today that governments actually have more power than corporations. Governments need to kill one bank - I'd suggest to do it to Goldman Sachs pour l'exemple - just cancel their general banking license, and their corporate registration.

As the people I talked to in NY (ie Wall St)  and DC over the past 2 days said right away: Obama would get 200 million votes if he did that.

Which brings us back to ratings agencies: they are one of the places where power has been wrestled away from democratic institutions to markets-based intermediaries, and that power nees to be grabbed back.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Thu Mar 25th, 2010 at 10:11:03 AM EST
Jerome a Paris:
"It's a slap upside the head of the government," said Mitchell Stapley, the chief fixed-income officer in Grand Rapids, Michigan, at Fifth Third Asset Management, which oversees $22 billion. "It could be the moment where hopefully you realize that risk is beginning to creep into your credit profile and the costs associated with that can be pretty scary."

That would be the government that got much deeper into debt saving banks and financial institutions? Oh, but the risk is going on with public services and social support mechanisms (such as they are)? Cut all that back and Fifth Fourth Third Ninety-Ninth Asshole Management in Grand Rapids, Michigan's chief fixed-income officer will say something positive about the government (= the State in European language) ?

There are days I dream of the guillotine.

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Mar 25th, 2010 at 11:24:13 AM EST
[ Parent ]
Today the local media is waking us with claims that Germany is acting concertedly to depress the €uro, fostering exports and local investor confidence. After all, when the trouble was with private banks there was no hesitation in putting on the table several times over the handful of thousand million euros Greece needs to refinance its budget.
(from Luis de Sousa's latest diary, with my emphasis)

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 11:42:58 AM EST
[ Parent ]
I read an analysis recently where Merkel was similarly resistant to a bank bailout--until she learned the extent to which German banks were exposed, and only then did she act. The article pointed out backroom fighting between Merkel and the Bush administration. Of course, in the end, Merkel went for the bailout, and German banks also received $20 billion in US bailout money.

So, we're talking about self-interest here.

by Upstate NY on Thu Mar 25th, 2010 at 01:46:53 PM EST
[ Parent ]
The markets have now decided that a company regulated by a government is more likely to have money than said government
A few thoughts
  1. The markets can remain irrational longer than anyone can remain solvent
  2. Why are governments paying any attention? Do they also believe market irrationality can outlast the solvency of a fiat-currency government? Have they forgotten markets exist because governments allow them to?


The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 11:51:55 AM EST
[ Parent ]
Markets are a law of nature: governments are a man-made construction.

Well-known fact.

by Colman (colman at eurotrib.com) on Thu Mar 25th, 2010 at 11:56:19 AM EST
[ Parent ]
Why do governments pay attention?

Because there's a weird belief that the markets may not be willing to lend money to them...

Of course, the history is that third-world countries have frequently managed to accumulate more debt, even after serious defaults... so I'm not really sure what the issue is... but maybe I don't really understand it.

As an example (because I don't really understand) I'm often being told that if the UK government doesn't present a "serious" plan to cut the deficit then it will not be able to raise the money it needs through sales of "gilts."

Maybe you can interpret that for me?

by Metatone (metatone [a|t] gmail (dot) com) on Thu Mar 25th, 2010 at 12:51:53 PM EST
[ Parent ]
Interpretation:
Thus we are so sensible, have schooled ourselves to so close a semblant of prudent financiers, taking careful thought before we add to the 'financial' burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment. We have to accept them as inevitable results of applying to the conduct of the State the maxims which are best calculated to 'enrich' an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time.
(Keynes)

The assumption here is that the UK government cannot spend the money it needs into circulation and tax any inflationary excess out of circulation. I say cannot in the sense of it is unthinkable not it is impossible.

In a more conventional fashion, the Bank of England could create new fiat money to buy gilts newly issued by the Exchequer at as low a yield as the Bank of England saw fit in order to control inflation. It is also assumed that this cannot be done.

Instead, the government must pay interest to wealthy people and institutions for the privilege of using their money, which actually exists by government fiat.

The brainless should not be in banking -- Willem Buiter

by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 01:02:41 PM EST
[ Parent ]
Metatone:
Maybe you can interpret that for me?

Disaster.Capitalism™

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Mar 25th, 2010 at 01:07:40 PM EST
[ Parent ]
Especially in a deflationary environment the U.K. government could just create money instead of issuing a bond that has to attract a buyer. Or the BOE could buy the bond and create the money based on the bond. Little different than the US Treasury issuing Greenbacks during the Civil War. The problem is getting leaders who see the needs of the whole society as trumping those of the monied elites.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Mar 25th, 2010 at 01:48:59 PM EST
[ Parent ]
And the problem with getting politicians who put the welfare of the society above that of the monied elites is that their minds have been systematically poisoned by bogus economics for the last forty years.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Mar 25th, 2010 at 01:51:18 PM EST
[ Parent ]
"Their" = the electorate.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Mar 25th, 2010 at 01:52:47 PM EST
[ Parent ]
But the USA would have to set up a lending bank to let the big banks fail.

Here in the USA, the mood is that Communism = health care ides that the GOP proposed just last year.

Hard to see us setting up a lending bank to keep the economy flowing.

by Upstate NY on Thu Mar 25th, 2010 at 01:51:00 PM EST
[ Parent ]


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