Another worthless rating

On Friday, Standard & Poor’s grabbed the economic and political world’s attention by downgrading the long-term sovereign debt of France. Not only has France lost its AAA rating, but it has also been given a “negative” outlook; a similar fate befell Austria.

While nine other euro-zone countries were also downgraded, none is as important as France, which is second only to Germany in economic clout.

Interestingly, over the weekend I found myself watching the film Inside Job, which is highly critical of the firms involved in the financial crisis of 2008.

At one point, the film focuses on the role of ratings agencies, which infamously assigned AAA ratings to the collateralized debt obligations that imploded, sparking the collapse of Lehman Bros. and the firesale of Merrill Lynch and Bear Stearns.

When called to testify before the U.S. Senate, the heads of Moody’s, Standard & Poor’s and Fitch all claimed that their ratings were protected under the First Amendment, and were simply “opinions”. These opinions, they said, should not be considered endorsement s of any rated security.

Specifically, ratings should not be taken as statements of fact, they argued, nor should they be used as the basis of investment decisions.

Read: SEC may sue S&P

By the admission of the people who issue them, these ratings are worthless.

And yet they remain the bedrock of trillions of dollars in fixed income investments: most pension funds are scarcely allowed to touch a bond rated below AAA.

On Monday, the world woke up to a conflict of opinions: Standard & Poor’s sticks to its story that France’s debt isn’t as stable as it was last month, while rival rater Moody’s has come out saying its rock solid.

“Sovereign Ratings are private credit opinions that command both deference and controversy inside and outside markets,” says Jan Randolph , director of Sovereign Risk at IHS Global Insight. “Borrowing costs ultimately matter much more because they actually bite—but are also not necessarily a good indicator of crisis lying ahead.”

So far, the market agrees with Moody’s, and France’s borrowing costs have fallen.

It’s an interesting dichotomy, and one that pits the research department at the ratings agencies against those of the firms making markets in various equities. Perhaps it’s even the first salvo of the buyers telling the raters their days are numbered.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.