Saturday, 28 April 2012

Spain's Downgrade... Too Much or Not Enough?


Spain’s unemployment rate has reached an 18-year high of 24.4% as announced this Friday. This is up from the 22.9% reported last quarter and close to the highest level on record. The distribution of this rate is even more appalling, as more than half of those under 25 years old are unemployed. As a reflection of these dim economic times across the pond, Spain’s credit rating was downgraded to BBB+ on Thursday. What is ludicrous about this, however, is the fact that Spain’s debt is still considered investment grade despite all the structural issues it faces and an unemployment rate higher than the US unemployment rate going into the Great Depression, which maxed out at 21-22%.

This brings into question, once again, the accuracy and credibility of ratings agencies. In 2009 Moody’s issued a report stating that “Investor fears over Greek government liquidity was misplaced” six months before the country started seeking a bailout. Even more absurd were the ratings agencies AAA ratings of the debt that caused the subprime mortgage crisis just a few years ago. Last but not least concerning was the S&P’s $2 trillion miscalculation of US debt before downgrading it last August.

While politicians often criticize ratings agencies for jumping the gun on downgrading government bonds, back in 2008 they were much too late to downgrade the CDO’s responsible for the crisis. The problem is the conflict of interest these agencies face when rating sovereign or corporate debt and other securities. It can cost anywhere from $1500 to $2.5 million to be rated, so agencies have a strong incentive to give their clients the ratings they want versus the ratings they deserve.

Solving this problem is no simple task, however as Aditya Chakrabortty argues, “The obvious solution would be to take this public service into public hands. Let's have a ratings agency run by the UN, funded by pooled contributions from both lenders and borrowers ... Let's make the ratings business a utility, rather than a semi-cartel that intimidates elected politicians and rakes in excess profits. It's time to break up the bullying double-act." While the logistics and feasibility of this may take years to figure out, it’s a worthwhile solution to consider for our own good as future investors if no one else’s. 

- Vivien Sung

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