Rating Agencies: Clueless Know-It-Alls

It happens only once in a while: one of the truly big players in the international finance market admits it has made a mess — a mess that cost taxpayers throughout the world hundreds of billions of euros, ruined banks and sent firms reeling.

Exactly two years ago, the powerful American rating agency Standard & Poor’s acknowledged it had been valuing securities, which were collateralized with U.S. real estate loans, far too highly — with the highest credit rating “AAA.” On July 10, 2008, it drastically downgraded 902 of these investment products in one fell swoop. Much of this paper thus became only “junk,” with the chance of remuneration unlikely.

Only two months later, the New York investment bank Lehman Brothers went bankrupt. Has anything changed today? Hardly — the three big rating agencies — S&P, Moody’s and Fitch — still act like they know it all, and that they’ve never known it better. No wonder a worldwide storm of indignation has been brewing over them for months.

Critics accuse the rating agencies of conflicts of interest, because they are paid by the same exact banks whose investment products they evaluate. Professor Thomas Straubhaar, Director of the Hamburg Institute of International Economics, expressed criticism to Focus: “The rating agencies are the umpires of the financial system. There is speculation that they are in bed with the players, the banks. The banks pay the agencies, and on top of that, they take a look at the different umpires before the game and then choose the one who is most appealing to them.”

The idea of a European rating agency, however, appears impossible. The worldwide financial markets would hardly accept it. Financial scholar Straubhaar therefore advises a radical solution: “The rating agencies must be deprived of power,” such that market participants no longer take them seriously. “Their judgments should only present one opinion among many. Whoever wants to listen to them

can do so.”