How Not to Cure Financial Fever

Since last summer, rating agencies have been at the center of heated debates on both sides of the Atlantic. In America, Standard & Poor's downgraded US debt, traditionally rated AAA, in order to signal a limited increase in financial risk; in Europe, Moody's drastically revised its outlook on Portugal, thus drawing criticism on the part of the (Portuguese) president of the European Commission.
The accusations that politicians and technocrats have moved against rating agencies, which have the thankless task of giving investors timely warnings about risk, are somewhat surprising. In fact, policymakers, by appearing indecisive in addressing the storm agitating markets, have added to the fears of investors (usually depicted in TV news programs as greedy speculators bombarding bond markets with naked short selling, while they are often investment funds worried about saving their and their clients' skin). On one side, we have the mediocre last-hour compromise reached by the US legislature in August to stave off the risk of insolvency on Treasury bonds; on the other, the difficulties of eurozone governments in addressing the crisis of sovereign debt in ways that were both effective and politically acceptable to German public opinion. Faced with procrastination and indecision and limited and belated will to intervene on the part of governments, it would have been difficult for the custodians of ratings to justify inaction, all the more since they were accused in 2008 of not having warned markets about the progressive worsening of the financial situation.
By going back to the statements made by European politicians during the summer, one gets the impression that since they are unable to cure the fever, they might be tempted to break the thermometer. Two proposals are indicative of this.The first, seemingly shared by European Commissioner Michel Barnier and IMF Director Christine Lagarde, is to prevent agencies from divulging ratings on countries which are recipients of rescue packages. In addition to being disconcerting (it is about forbidding someone to express their own opinion), the idea is likely to be counterproductive: if agencies are prevented from communicating with markets, they not only won't be able to cut ratings when this is necessary, but will also be prevented from reassuring investors in the case of positive news. Faced with such an informational blackout, it's unlikely that investors will have orderly reactions, and content themselves with the press releases of some EU summit saying that the situation is (at the moment...) under control.
The second proposal is to create with European (public) funds our own rating agency to be counterposed to the excessive power held by malicious US analysts. The idea is not persuasive. Firstly, the downgrading of US debt shows that rating agencies are not biased toward the country where they are legally headquartered. Secondly, an agency financed (and controlled) by the public sector could well be too benevolent toward the issuances of its shareholder. Lastly, a rating approved by the EU or a national government would put a seal of quality in the eyes of investors, providing an implicit guarantee against fears of a default (but it would not eliminate the risk that such a default might actually occur).
The most urgent kind of reform is not about agencies but regulation. In the past, norms have given ratings a semi-legal status, by allowing for instance banks to have smaller capitalization requirements if they bought triple-A bonds. Such norms should be reviewed, in order to bring ratings back to their original role: opinions issued by specialized operators. It will be hard to dismantle them, however, since before depriving ratings of their regulatory function, we would need a better system to measure risk. Something which is yet to be seen.