By: Dr. Mike Campbell
Ratings agencies are very much the financial world’s equivalent of the turf accountant, or bookmaker. Their function is to scrutinise financial investment tools such as corporate and sovereign bonds and provide an impartial evaluation of the risk inherent in the investment. Since the agencies make their money from a percentage on the bond issues that they rate, they could be said to have a vested interest in the success of an issue. The agencies came in for particular criticism for providing a clean bill of health for securitised mortgage debt – the sub-prime loans which triggered the global financial crisis. They have also been responsible, for decades, for rating sovereign debt and, until relatively recently, stood silently by whilst the world’s nations build bigger and bigger mountains of debt.
The lowest risk bonds are given a AAA status and issuers have to offer the lowest rates of return to attract investors since (according to the ratings agencies) the perceived risk of a default on the investment is as low as possible. On the opposite end of the spectrum are junk bonds which are perceived to be at the highest risk of default. Investors in these bonds might well get their fingers burned – as investors in sovereign Greek debt just discovered – and so the yield on these vehicles is much higher reflecting the greater risk associated with them. Since when the yield on sovereign debt goes up, the money a nation has to pay to service its debts also rises, the whole area of ratings agencies and sovereign debt is of great importance.
Fitch has recently followed suit with Moody’s and placed the UK’s AAA rating on “negative” outlook, meaning that it could be degraded at some stage over the next “few years” should the government fail to contain the level of public debt. The economic value of such a statement should be called into question – it’s like saying the share value of Moody’s could fall if the Securities Exchange Commission identifies it as the target of an insider trading enquiry “in the next few years”: stellar stuff!