This is How Government Works if You Allow It

Last night the EU parliament approved a new series of regulation of the rating agencies, such as Standard & Poor, Fitch, and Moody’s.  They are now to be liable for, among other things, “grossly negligent” ratings.  Issuers who own 10% or more of one of the agencies are forbidden to use that agency to issue a rating on their securities; ownership of 5% of a rating agency must be publicly disclosed.  Every three years issuers of certain complex products must change at least one of the agencies rating their securities; the one they change out must then wait four years before being permitted to rate another security of that issuer.  The agencies are also to be required to issue a uniform, mathematically-expressed rating in addition to their alphabetical ratings.  By 2020 no investor is to be required automatically to regard an issued rating (presumably this is to insulate fiduciaries from being prohibited from making investments unless they have a particular rating).

Now, a good-faith argument can be made for all of the above measures.  The whole ratings game can, just as with any other repeat-player dynamic, easily mutate into a mutual accommodation society.  There seems to have been more than a tad of that going on in the run-up to the 2008 collapse.  Of course, the single biggest part of the bubble — the U.S. housing bubble — was not only being deliberately inflated by Fannie Mae and Freddie Mac, but its pet Congressmen were publicly and vehemently denying any problems at all with their donor’s portfolio or finances.  The statements of, e.g. Maxine Waters, Barney Frank, and Chris Dodd were far more egregious than anything put out by S&P or any of the others.  But we aren’t talking about that.

 The question that’s niggling away in the back of my mind on this particular set of regulations is:  Why only now?  All of the problems with rating agencies have been known for years; their role in the 2008 collapse has been known for years; the measures adopted by the EU are not terribly complicated measures.  Why has it taken just over four whole years to enact a fairly modest slate of reforms to the industry?

OK; I admit I wasn’t being entirely forthcoming in that preceding paragraph.  The Eurocrats tipped their hand.  Their sudden concern for all the poor downtrodden investors out there has got bugger all to do with what Moody’s has to say about issues of Ford Motor Corporation, and everything to do with what it has to say about whether it’s a good idea to keep buying European sovereign debt.  I deliberately didn’t mention above all of the new regulations.  F’rinstance, the agencies are now prohibited from issuing ratings with respect to EU-area sovereign debt except three times a year, and only when the European exchanges are closed.  The proposal was initially floated to forbid them outright from expressing an opinion at all about whether Greece, which within the past couple of days has just got another few dozen billion Euros, at zero percent interest, and obtained extensions on its existing debts, and is proposing write-downs of its fellow-states’ holdings, might not be the best place to park your money.

According to the linked article, those super-dooper diligent Eurocrats are have been just worrying themselves sick (cue Pete Puma:  “I’m the little feller’s mother and I’ve been so wooooorrrried about him!“) that the ratings agencies have been over-valuing private issues of securities.  Bullshit, as the same article makes clear:  They’re worried that by cluing in the pigeons investors in EU sovereign debt that buying paper from such paragons of financial probity as Greece, Italy, Spain, Portugal, and/or France is shooting one’s money up a wild hog’s ass, those worthies might have to pay market price for their promises to pay the money back, and that the market price for their worthless paper might actually fluctuate according to their own behavior. 

When you ponder those additional nuggets, the underlying purpose behind absolving investors from paying attention to whether S&P says a particular bond is junk or gilt becomes a bit clearer.  Who are the big purchasers of sovereign debt?  Pension funds and financial institutions.  They are, in other words, investors who are bound by fiduciary obligations, or whose own soundness is at issue on a daily basis.  If, for example, Dresdner Bank is required by German banking regulation not to hold more than X% of paper in its portfolio that is rated Aab or worse, then it cannot legally continue to purchase worthless Greek paper.  If the pension fund for, say, a bunch of Dutch shipyard workers is held to a fiduciary’s standard of prudence in investing its members’ retirement assets, then wouldn’t it be nice for the EU simply to declare that putting the whole wad in Portuguese sovereign debt is just hunky-dorey?

Just to make the actual agenda even more abundantly clear, even to someone as dense as a NYT pundit:  One of the German SPD members has demanded nothing less than — you really do have to admire the brass on this guy — a specifically EU-run ratings agency to express opinions as to the soundness of the EU’s and its member states’ obligations.  Really.  He really said that.

You know, if only the emperor in the story had thought to pass a decree declaring it illegal to express an opinion on another person’s clothing except on three stipulated occasions per year, he’d have done so much better.

Updated (28 Nov 12): To add link to relevant video of Pete Puma.

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