Who are the ratings agencies?
The big three agencies are Fitch, Moody’s and Standard & Poor’s.
What they do is assess how likely a borrower is to be able to repay its debts and help those trading debt contracts in the secondary market.
That means for those trading debt contracts such as Treasury gilts after they have been issued, ratings agencies help assess a fair price to charge. Ratings agencies have been criticized for having too much clout in jittery markets during the financial crisis. They were widely attacked for failing to warn of the risks posed by certain securities, in particular mortgage-backed securities.
Losing your rating or being downgraded can have a fatal effect on your country’s ability to borrow money on the markets.
Thanks to the three big agencies, we can bring you the ratings of countries around the world as of today. Because each agency’s approach is slightly different, we have color-coded them in three broad categories too.
In layman’s terms, the 2008 crisis started when thousands of US homeowners stopped paying interest on their mortgage. The crisis spread because thousands of bankers and fund-managers had foolishly backed those mortgages, and so lost a lot of money themselves. They did this partly through their own lack of foresight, but also because of the ratings agencies’ failure to warn them of the risks involved. In the run-up to 2008, a staggering proportion of mortgage-based debts were rated AAA, when in fact they were junk. The same goes for groups such as Enron, Lehman Brothers and AIG. Days before they went bust, Moody’s, S&P, and Fitch all still rated these failing companies as safe investments. Shockingly, more than half of all corporate debt ever rated AAA by S&P has been downgraded within seven years.
Part of the problem is that ratings agencies are funded by the very companies they rate. If you want to be rated, you must pay an agency between $1,500 and $2,500,000 for the privilege, depending on the size of your company. In theory, this creates a conflict of interest, because it gives the agency an incentive to give the companies the rating they want. It could explain why, for much of the past decade, agencies seemed happy not to question either the risks banks were taking, or the accuracy of their accounts.
There are more than 150 ratings agencies worldwide, but in order to have any credibility, companies really need at least one of Moody’s, S&P and Fitch on their side, and preferably all three. The first two firms each control around 40% of the market. Fitch has about 15%, and is usually engaged when S&P and Moody’s disagree significantly about the creditworthiness of a debt. This generally happens because S&P measures how likely a debtor is to default, whereas Moody’s rates how long the default is likely to last.
At the beginning of the 20th century, there were no ratings agencies, and very few ways of telling which of the many emerging securities were worth investing in. There was a gap in the market, and the first person to fill it was a Wall St errand boy called John Moody. In 1900, aged 32, he published Moody’s Manual of Industrial and Miscellaneous Securities, a compendium of information on thousands of financial institutions. The book sold out in months, and an industry was born. Poor’s Publishing Company emerged in 1916, Fitch in 1924.
For countries such as Britain, the USA and France, the threat of a downgrade is not as serious as it has been for other European countries. Moody’s negative outlook did not hit the pound or government bond prices hard, and the FTSE 100 was affected only slightly. Even if Britain’s rating fell to AA1, the state is unlikely to be seriously affected because most other countries are in the same situation.