LORDS

Don't shoot the messenger: Lords message to EU Governments on Euro debt crisis

21 July 2011

The credit rating agencies are not to blame for the eurozone's debt crisis says the Lords EU Economic and Financial Affairs and International Trade Sub-Committee in a new report, Sovereign Credit Ratings: Shooting the Messenger?

The committee's four month-long inquiry into the agencies' influence on the EU's sovereign debt crisis concluded that their role in the 2008 banking collapse, which was rightly criticised, should not colour assessments of their decisions on EU sovereign debt.

The agencies have caused controversy each time they downgraded further the sovereign debt ratings of Greece, Ireland and Portugal. But the Committee says the downgrades "merely reflect the seriousness of the problems" in some Member States. The valid charge against the ratings agencies is not that they precipitated or exacerbated the euro area crisis, but rather that they "failed to identify risks in some Member States" which, in some cases, had been building for many years.

Recommendations 

  • Market investors must take responsibility for their own decisions. Sovereign credit ratings are ultimately subjective predictions which rely on personal judgements by rating agency staff. It is inappropriate to follow them blindly and use them as the sole basis for investment decisions. Investors should consider a range of market indicators when deciding whether or not to buy EU Member States' debt, and should bear in mind the principle of caveat emptor.
  • EU Governments should focus on correcting the flawed market structures which give undue weight to the rating agencies' opinions. The committee strongly supports efforts to reduce the role that credit ratings play in regulations, investments mandates and private contracts. Given the role that ratings currently hold in regulation, it is only appropriate that EU governments should co-operate with the credit rating agencies so that sovereign debt ratings are as accurate as possible. Commissioner Barnier's proposal that sovereign debt ratings be suspended for countries in international financial assistance programmes is wholly impractical and smacks of censorship.
  • Credit rating agencies must learn from their failure to identify mounting risks in some euro area Member States. The agencies did not challenge rigorously enough the assumptions on which they based their assessments of Member States’ sovereign debt. They were not alone in failing to spot the seriousness of the problems building in the euro area, but this does not absolve their failure.
  • The European Commission should not press forward with proposals to establish a publicly funded European credit rating agency. They should, however, consider launching a thorough competition inquiry into the credit rating industry.  Any publicly-funded European credit rating agency would lack credibility with the markets. Proposals to give sovereigns more advance warning of rating changes are also flawed.

Committee Chairman, Lord Harrison, said:

"The ratings agencies have attracted a huge amount of attention and criticism as they have downgraded the ratings of Greece, Ireland and Portugal over the past year. They failed to spot risks which had been building within these states long before the crisis hit. Although they were not alone in this failure it does not absolve them of responsibility.

The criticism they have faced, however, has largely been unjustified. The rating agencies did not precipitate the crisis, nor do we believe it is possible to say with any certainty that they exacerbated it. Valid concerns over their role in the 2008 financial crisis should not be allowed to colour an objective assessment of their decisions relating to the creditworthiness of some Member States' sovereign debt. Their recent downgrades merely reflect the seriousness of the problems facing countries such as Ireland, Portugal and Greece.

Ratings are ultimately subjective predictions. Instead of criticising these downgrades, Member States should be working to amend the flawed financial rules which lend these judgements excessive weight. Investors, meanwhile, should view ratings as opinions that need to be balanced and confirmed by other market indicators. The final responsibility for investment decisions lies with investors".

The Committee will send its report to the European Commission and expects responses from both the Commission and the Government. The Commission is expected to report on the results of its consultation on credit rating agencies shortly and the Committee will scrutinise any resulting proposals it makes

Further Information

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