In recent weeks the Irish government has become very much preoccupied in reversing the decision by the major credit rating agencies Moody’s, Standard & Poor’s and Fitch’s Ratings to downgrade Ireland’s credit rating from the prestigious AAA. According to official sources the triple A rating is bestowed upon securities considered the lowest risk to investors, and, unfortunately given the current state of the public finances and banking crisis , Ireland is no longer considered a “low risk” destination for capital. Here’s the question though, why should the Irish government be so preoccupied with the opinion of those that have gotten things so wrong lately?
The criticism of the rate agencies needs to begin by examining the role they played over the past decade. During the 1990s the rating agencies had two ongoing problems. Firstly, how could they encourage more investment in financial products? Secondly how could they solve the continuing problem that mortgage banks faced in having to wait decades to recoup finance granted to new home owners? By marrying these two issues a single solution began to emerge to the two separate problems.
The rate agencies found that investors were always keen to invest in low risk securities. Therefore by bundling hundreds of mortgages into a single security and granting it a AAA rating the rating agencies solved problem one. Investors did not need to know what properties were in the bundle only that the rating agencies had granted it a AAA rating – and the capital flooded in! Mortgage banks were delighted as they could sell their loans into these securitized bundles and get a much quicker return on their original investment thanks to global investors who couldn’t get enough of these “safe bets” – hey presto, problem two sorted!
A new problem has emerged however as a conflict of interest has arisen. The rate agencies have become the gatekeepers and effectively took over the role of the banking sector in monitoring investments instead of fulfilling their original role as impartial observers. This is probably why these same agencies believed sub-prime mortgages were of low risk on the shortly before the credit crunch and why Ireland was deemed to be in “good shape” on the eve of the global financial crisis. The oligopolistic nature of this three firm dominated market calls very much into question the practices of these firms. One needs to question now maybe it should be Ireland rating these agencies and not the other way around!
