February 04, 2015

If used as geopolitical weapons beware, credit ratings can be more dangerous to your homeland than to your enemies

Sir, FT Alphaville should be commended for bringing up a discussion on what credit ratings can signify and which, even though it could have a fundamental impact on our future, has been so irresponsibly neglected, “Credit ratings warped by geopolitical pressures”, February 4.

Alphaville quotes Guan Jianzhong, the president and CEO of Dagong Global Credit Rating Company of Beijing saying:

“The global credit crisis has shown us that credit rating concerns the safe development of the human society… The current international credit rating system is favourable to the countries behind it, who apply their value and ideologies to the rating standards… It becomes the origin of the crisis and is no longer able to shoulder the credit rating responsibility for the world… However, the human society in the credit economy stage needs fair and just credit rating.”

That puts the finger on a thousand aspects… like for instance what is “fair and just credit rating”?

And it is completely in line with what I argued in a letter published by you in January 2003, namely: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds”… and all this made so much worse in June 2004 when Basel II’s credit-risk weighted equity requirements for banks, exponentially leveraged the dangers of credit ratings.

But let me here just focus on “credit rating concerns the safe development of the human society” in order to repeat to FT, for the umpteenth time, the following warning:

Risk-taking is the oxygen of any development, and so there is nothing as contrarian to a safe development of the human society, as an excessive risk aversion… such as that one imposed by the Basel Committee on our banks.

Now you may observe “What about all those excessive risks banks took and which caused the crisis?” and to which I would respond, again for the umpteenth time: “This crisis, as all bank crises in the past, have been caused not by excessive exposures to what was considered risky, but by excessive exposures to what was ex ante considered safe but that ex-post turned out to be risky”.

Sir, I have been arguing for years that since the information contained in credit ratings is already cleared for by banks, in interest rates and size of exposure, it is sheer lunacy to reuse that same information when setting capital requirements… something which should have much more to do with the possibility of the credit risks having being wrongly perceived.

And I have also argued that to distort the allocation of bank credit to the real economy, based on perceived credit risk, serves absolutely no social purpose. If regulators absolutely must distort, it would better of they did it with for instance ethic-ratings, sustainability-ratings or potential-of job-creation-ratings.

Alphaville introduces Guan Jianzhong’s comments with “It is no joke the way modern finance is being warped by geopolitical pressures and ambitions”. Indeed, but careful, the use of credit ratings as weapons can easily turn out to be more dangerous to your own homeland than to your enemies.

PS. The article is a consequence of Fitch Ratings placing a BBB minus, barely investable rating on [Russian] Gazprom. Beware, good ratings can also take some down, ask Greece.