Sunday 25 March 2018

European rating agency wouldn't have credibility

Jose Manuel Barroso's claim of anti-EU bias is fanciful and ignores the real issues, writes Colm McCarthy

EUROPE'S sovereign debt crisis worsened seriously during last week as the inadequate European policy response fumbled on. The ratings agency Moody's downgraded Portuguese government debt to junk status on Wednesday, which renders pretty implausible the notion that Portugal will be able to sell bonds again for the foreseeable future. Everyone (except the fumblers) has already given up on Greece and both Portugal and Ireland are edging ever closer to the same fate.

The downgrade sent the market in the debt of several not-yet-insolvent eurozone members, especially Spain and Italy, into dangerous territory. Italy has more sovereign bonds in issue than any other eurozone member and its 10-year yield reached almost 5.30 on Friday. The Spanish 10-year bond is close to 5.70. These interest costs are in all likelihood beyond what is affordable for these countries.

Should next-in-line Spain go under and require an EU/IMF rescue, Italy will follow quickly.

These countries are too big to save in the framework of the existing bailout arrangements and there will be a second and catastrophic leg to the world financial crisis if they go under. However big a financial crisis, a bigger one can always be manufactured through pretending that the first one has been fixed when the financial markets are screaming that it has not.

Another ratings agency, Standard and Poor's, last Monday gave the yellow card to a wheeze dreamt up by the French banks to pretend that private lenders were taking a meaningful hit in the next instalment of the Greek bail-out. The agencies were supposed to pretend that no event of default would take place, while everyone else was meant to pretend that there would, since the creditor banks were writing off some Greek debt.

If you do not understand how both of these views could be held simultaneously, you could get a high-flying job in European crisis management.

It would have been nice, from the perspective of those charged with the resolution of the eurozone crisis, if the main ratings agencies had issued a joint statement to the effect that everything is just fine and that the European policymakers are doing a thoroughly praiseworthy job.

But sadly the agencies are doing what they are supposed to do, which is to give an independent assessment of the credit-worthiness of governments and of the bonds they issue.

They failed to do this through the middle years of the last decade, and it is a pity that they have only recently begun to do their work properly. For their pains, they have become the problem. Jose Manuel Barroso is the president of the European Commission.

"Today there is a growing consensus about what can be the proper level of regulation of the rating agencies and it can be an important contribution of what we want -- a dynamic private sector," Barroso told reporters at a joint press conference with Polish Prime Minister Donald Tusk on Friday.

"The commission will come with some proposals in the autumn; I cannot yet at this stage anticipate what will be the content of the proposals," he said.

EU officials slammed the credit ratings agencies this week after Moody's slashed Portugal's debt to junk status, plunging the markets back into turmoil and calling into question a second bailout for debt-stricken Greece.

A former Portuguese minister, Barroso said the Moody's downgrade signalled an anti-European bias and suggested it was time for a European ratings agency to emerge as a counterweight to the US-dominated groups.

He added that it was "strange that in such an important matter there is not a rating agency originating in Europe" -- but insisted it was not the EU's job to set up such an institution.

"As far as the creation of a rating agency at the European level -- of course it is not for the European Commission to create a rating agency. This is in fact clear. I know that some people, some actors in Europe where there is a lot of expertise in these matters, are thinking about the possibility of creating one or more rating agencies," he said. More competition in the ratings domain could only serve the public interest, he added.

"We know that when there are oligopolies there are sometimes attempts to abuse the dominant position or market manipulation, so the more competition the better -- this is our credo."

For sheer unabashed witlessness, this is really hard to beat. The three main ratings agencies -- Fitch is the third -- are all US-based.

Barroso's outburst suggests that if there had been a European agency enjoying EU regulation, it would have concluded that Portuguese debt was top of the range and that the wheeze dreamt up by the French banks was splendid in every way. He is probably right. Such an agency would not last a week though, since no one would pay a blind bit of attention to its utterances. His wistful regret that the EU Commission cannot set up its own ratings agency should touch the heart.

Rather more serious is the allegation of market manipulation. If a ratings agency were, for example, to short Portuguese bonds and then issue a negative report pushing down the price, this would be very serious.

Actually, it would be a crime. If Barroso has evidence that crimes along these lines have been committed, he has a duty as a citizen to bring the matter to the attention of the local police. If he has no such evidence, he should remind himself that he is the president of the European Commission in the middle of an existential crisis for the single currency project.

The sole priority for the eurozone should be to prevent the spread of bond market contagion to Spain and Italy, launching a new financial crisis on a scale beyond the rescue capability of the EU and IMF.

If the crisis affecting Greece, Ireland and Portugal can be confined to those three countries there is a reasonable chance that Spain and Italy will retain access to the markets. If the contagion-spreaders in control of European policy continue the shambolic performance of recent months, complete with messenger-shooting vignettes from Barroso, Spain and Italy will be swamped and the costs of resolving the Greek, Irish and Portuguese problems will begin to look like a bargain.

The Spanish Treasury managed to sell some three- and five-year bonds during the week, paying higher interest rates than they would have liked. But at some stage solvent-for-now issuers such as Spain must face the music in the 10-year market or their outstanding debt bunches shorter and shorter.

If the Spanish 10-year interest rate edges much above 6 per cent, the game will probably be up.

An alternative to setting up 'Barroso and Company' as a fourth independent ratings agency would be a three-part scheme to end the bond market train-wreck.

Part one: compute the amounts of debt relief required to get Greece, Portugal and Ireland into a position to regain market access. Part two: allocate the losses in a sustainable manner to the taxpayers of those countries, European taxpayers, and creditors. Part three: break the news gently to all concerned.

One glimmer of hope emerged last week.

European banks are upset that the next set of stress tests on the 91 largest banks are to be too severe. The sham stress tests last summer (AIB and Bank of Ireland were awarded rosettes!) played a key role in destabilising the markets, but the new European Banking Authority (EBA) which oversees the tests is insisting that banks acknowledge their exposure to dodgy sovereign debt this time round.

Since the first step in addressing a problem is to acknowledge its existence, it is good to learn that adults are in charge at the EBA.

The test results are scheduled to be released next week. If they show that only a handful of banks have serious capital deficiencies, this will not be believed. Results showing that numerous banks have serious problems should be welcomed and will be believed by those dreaded American ratings agencies.

The tests might even provoke the European political leadership into addressing the European banking crisis, now entering its fourth year.

Writing in the Financial Times during the week, Martin Wolf resorted, appropriately given the pivotal role which the fate of Spain will play, to a bullfighting analogy.

This is the moment of truth for the eurozone.

Colm McCarthy lectures in economics at UCD. He headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, An Bord Snip Nua. He is also the author of the report into the semi-state sector from the Review Group on State Assets and Liabilities.

Sunday Independent

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