By: Dr. Mike Campbell

Ratings agencies are the bookies of the financial world. Effectively, their job is to set the odds on a bond issue such that investors will have a shrewd idea of the risk of default associated with a particular bond issue. Based on the ratings agency’s assessment, issuers will have to offer more (or less) interest on their debt vehicle in order to attract investors; consequently, they have a very influential role in the financial world. The ratings agencies are commercial businesses and are not answerable to individual governments or international institutions.

This week, one of the three major ratings agencies, Moody’s, downgraded its evaluation of Portugal’s credit worthiness to “junk”, a move that has infuriated the Portuguese and angered the European Commission. Moody’s cited the concern that Portugal would need a second EU/IMF to meet its obligations as the justification for their decision. "The timing of Moody's decision is not only questionable, but also based on absolutely hypothetical scenarios which are not in line at all with implementation. This is an unfortunate episode and it raises once more the issue of the appropriateness of behaviour of credit rating agencies." said Commission spokesman Amadeu Altafaj.
Greek Foreign Minister, Stavros Lambrinidis, described the behaviour of the ratings agencies during the sovereign debt crisis as “madness”, pointing out that they had worsened an already difficult situation. He noted that Moody's decision to downgrade Portugal's rating was not based on any failure on Portugal’s part to implement economic reforms. The downgrade has pushed the yield on Portuguese 10-year bonds above 11% which compares poorly with the 3% that Germany must offer on its own ten-year bonds.
There is considerable consternation in Europe that moves designed to roll-over Greek debt when bonds fall due will be regarded as a default by ratings agencies and could trigger a financial catastrophe. It has not been lost on European leaders that the rating agencies totally misjudged the investment status of sub-prime debt which, of course, was the origin of the global financial crisis.