Sovereign Credit Ratings: EUC Report

Lord Foulkes of Cumnock Excerpts

Tuesday 15th November 2011 Lords Chamber

[Lord Foulkes of Cumnock]

My Lords, I join in the warm congratulations to my noble friend Lord Harrison on securing the debate. I am a member of the European Union Select Committee, which is very ably chaired by my noble friend Lord Roper.

I joined the committee just as this report was being concluded, and although I welcome the report, I feel it does not go far enough. I disagree with much of the essence or strength of what has been said up to now. Some of the action of the credit rating agencies has, frankly, been scandalous and it needs more urgent action. As the Minister knows, I have raised it two or three times at Question Time, and although the Minister has been reasonably helpful and wrote to me recently about it, I am not sure that he or the Government are really seized of the concern that is widely held about the action of credit rating agencies and the urgency of action that is necessary.

It is quite ridiculous that three US-based agencies have 95 per cent of the global credit rating agency work. They are private companies, with their own shareholders, their own owners, who often benefit from the decisions made by those agencies. Whether my noble friend Lord Myners—who has disappeared suddenly—thinks they should get any credence or not, they are given great credence, not just by the media, but by a whole range of other people. Yet look at their record. Joseph Stiglitz, the Nobel prize winner, said that the subprime crisis would simply not have happened without the CRAs’ contribution. He says:

“They were the party that performed the alchemy that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the rating agencies”.

It was that subprime crisis which started the global financial crisis that we are currently in. Look at the accuracy of their forecasts. They gave positive ratings to AIG and to Lehman Brothers right up until the very moment of their collapse. What an astonishingly poor record that was.

I disagree with the report when it says, “Do not shoot the messenger—they did not exacerbate this situation”. The inherently pro-cyclical way of functioning aggravated the European sovereign debt crisis and pushed several European countries to the brink of bankruptcy. For example, explaining the reasons for Italy’s downgrade on 17 September this year, Standard & Poor’s put forward that,

“market interest rates are anticipated to rise”.

Of course, interest rates would only rise even further as a result of the downgrade by S&P, so it exacerbates the problem and you get this vicious cycle downwards. Of course the creditors are happy, and some of the people behind Standard & Poor’s might be making quite a bit of money out of it.

In the current European context, it is questionable where the true responsibility lies for the austerity and the dire economic consequences we see in nearly all of the European countries in the eurozone, and the social consequences resulting from that. Are democratically elected Governments really able to decide their fiscal and economic policies in full sovereignty and independence, or do Moody’s, S&P’s, and Fitch effectively assume true economic power in the European Union? I think that is a question that needs answering, and I hope we will get a response from the Government in relation to that.

Let us then go to the conflict of interest of credit rating agencies. As I said earlier, they are private companies, and as such their primary purpose is to seek profit and to enhance their market position. The experience of the recent crisis, as well as testimony of former employees of the CRAs, has shown that managerial pressure on analytical units is used in order to modify outcomes and to decide on ratings models which are more likely to enlarge the CRA’s market share in this respect. Accuracy would not seem to be the prime objective of the credit rating agencies.

I think the answer—I disagree with the noble Baroness, Lady Noakes, on this—is that we need to look to the European Union. If this Government were prepared to consider regulation and to deal with this as far as the United Kingdom was concerned, I would welcome that and look at it, but they have ruled that out. The noble Baroness said that she wants less regulation; that is why we need to look to Europe to see some ways of protecting ourselves. I favour the establishment of a European independent credit rating agency. First, such an agency would ensure that we become less dependent on the CRAs’ opinions and would use alternatives to risk assessment in legislation and regulation. Secondly, I would argue that competition between CRAs should be promoted, as some have said already, by lowering the barriers to entry to the market and by increasing transparency. Thirdly, the inherent conflict of interest which I have described in the predominant current business model would be bypassed through sound measures to combine different business models. Rating states and companies needs different criteria; using the same criteria for them does not work.

I would argue that the European Union has the power. I get concerned at this growing Euroscepticism that seems to be infecting both Houses of this Parliament. We saw it with the noble Baroness, Lady Noakes, and, I am afraid, with my noble friend Lord Myners. I am glad that my very good and noble friend Lord Roper is here. He is a long-standing supporter of the European Union and we should be enthusiastic still about what can be achieved collectively. Just a few days after Remembrance Day, we ought to remember why the European Union was set up in the first place. The European Union has an unequivocal mandate in anti-trust matters, determined by the treaty and by directive 2003/6/EC on insider dealing and market manipulation and its amendments, so it has the power to take action in relation to this. I would argue that it should take action.

In summary, the subprime crisis would simply not have happened without credit rating agencies. In the 10 years up to 2007, the revenues of credit rating agencies rose by 900 per cent. That is what they are in it for—to make money. The ratings delivered by credit rating agencies constrain decisions taken by Governments, by pension funds, by banks and by the ECB, because of the credibility given to them. As I said earlier, the three US-based credit rating agencies share 95 per cent of the market. Their business model is riddled with conflicts of interest, and I would argue that fixing credit rating requires tighter regulation of existing private agencies, as well as the establishment of a European independent credit rating agency.

I am not anticipating that the Minister will agree with what I have suggested, but I certainly hope that it will get a positive response from my colleague and noble friend Lord Eatwell, the shadow Minister.