US credit rating monopoly gone

The crisis in Ukraine is stressing relations between Europe and Russia. But now would be a good time for Brussels to send a heartfelt note of thanks to Moscow. It turns out that not every plan hatched in the Kremlin these days is a perfidious scheme to harm the interests of the European Union.

Russian Finance Minister Anton Siluanov has put forward a plan for Russia and China to set up a new credit ratings agency together. Moscow and Beijing want to create some competition to the all-too-powerful American ratings agencies -- Standard & Poor's, Moody's, and Fitch. That's very good news for Europe as well as for Asia and Russia.

Europe's economic crisis managers vividly recall the chaos unleashed by collusion of the American ratings agencies in the sub-prime lending schemes of American banks. The US agencies were instrumental in enabling the distribution of dodgy American financial instruments such as mortgage-based CDOs to unsuspecting bankers and other institutional investors in Europe, thereby crippling the solvency of the European banking system.

The Russian-Chinese initiative shows once again: Ownership of international monopolies by a global superpower should be avoided. The original core purpose of credit ratings agencies is legitimate and useful - it is very important to have sober, neutral agencies specialized in the valuation of financial instruments, in order to create transparency in markets. Yet if the dominant credit ratings agencies aren't really sober or neutral, but only pretend to be, then they represent a danger to the global financial system and to the economic health of nations.

Ratings agencies assess the financial status not only of corporations, but of states, provinces and municipalities. They assign scores meant to express the riskiness of investing in financial instruments (especially debt instruments) issued by a particular government or corporation.

Until the autumn of 2008, politicians and institutional investors alike relied strictly on the judgment of the main American ratings agencies about the safety of various debt instruments. They learned the hard way that the agencies were in bed with the American banks whose debt instruments they claimed be neutrally evaluating - not least because under the US system, banks pay credit ratings agencies to rate the creditworthiness of those banks' financial products.

At least until 2008, and perhaps since, when the American agencies downgraded a country's creditworthiness, investors quickly pulled their money out by selling the country's bonds. Interest rates on those bonds shot up. Refinancing accumulated and sovereign debt became expensive as a consequence, and the affected states immediately found themselves sailing in heavy financial and economic seas.

US Ratings Agencies as instruments of US geopolitical strategy

This allowed the US to use Wall Street as an instrument of geopolitical power. All too often, American credit ratings agencies' view of the world, and of the creditworthiness of states, was skewed by their partiality to American interests.

Or worse: The agencies sometimes actively engaged in politics, as they did in the context of the European debt crisis. As soon as Brussels had stabilized Greece's finances by means of a sovereign bond refinancing package, US credit ratings agencies downgraded Spain's sovereign bonds. Brussels reacted with help for Spain, and the US agencies quickly downgraded Portugal's bonds. Brussels rushed to help Portugal, and the US agencies went another round, this time further downgrading Greece's bonds. Step by step, they made it more difficult and expensive for European nations to refinance their debts and so intensified Europe's sovereign debt crisis.

It's true that some of the European states had accumulated excessive sovereign debt loads, but that had long been the case. The US ratings agencies hadn't previously shown any particular concern. Yet they suddenly set about downgrading one European nation's bonds after another, round for round, precisely during a period when Europe was attempting to get a grip on its sovereign debt and stabilize its public finances.

That speaks volumes - especially in view of the fact that the US, which is by far the most-indebted nation in the world, continues to be assigned a top credit rating by the very same Wall Street agencies.

Europe isn't the only region in the world that has suffered from American credit-ratings attacks. Moscow also recently experienced how expensive the consequences of a negative rating can be. During the Crimean crisis, two Wall Street agencies downgraded Russian sovereign debt. Standard & Poor's now assigns the sovereign debt of Russia, a powerful, nearly debt-free country blessed with an extraordinary wealth of natural resources, with a credit rating just one notch above junk-bond status. Interest rates on new Russian sovereign bonds shot up so much that Moscow had to stop issuing any more of them.

US Ratings agencies attack China

China also gets slapped down from time to time by the Wall Street agencies, even though it is widely accepted that the Chinese economy is in better shape than those of most of the major Western nations or of the other BRIC countries. Beijing recognized this pattern several years ago, and took action accordingly: China established its own credit ratings agency. Until now, however, its ratings were given little weight internationally.

Now that China and Russia plan to establish a common ratings agency together with several other Asian states that are expected to be invited to join in, the probability is rising that a breakthrough will result. That would be a major step forward. Ratings agencies compete for the attention and credence of institutional investors. This competition demands that they must be as neutral and accurate as possible in their ratings. Intensified competition between agencies based in different countries should serve to improve the quality and dependability of ratings.

It's a shame that the European Union has so far not had the courage to establish a major credit ratings agency of its own. Plans to do so were put forward, but have not been acted on; no-one could be found to finance such an agency.

It is politically inopportune, at the moment, for Europe to join the Russian-Chinese ratings agency project. So Europe will continue to be subject to getting shoved around by outside powers in the global ratings game.

Our columnist Frank Sieren is one of Germany's foremost China experts. He has lived in Beijing for twenty years.