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Sovereign Fear

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The European Parliament voted today to approve new credit rating agency rules. The package includes a number of measures to reduce reliance on credit ratings, address conflicts of interest, and make it easier to sue credit rating agencies. Another rule relates specifically to sovereign debt ratings. According to a European Parliament news release, credit rating agencies will only be permitted to publish unsolicited sovereign ratings "at least two but no more than three times a year, on dates published by the rating agency at the end of the previous year." In other contexts, unsolicited ratings are encouraged as a way to improve the information available to investors.

Sovereign fear seems to be driving this move. Seeking to manage credit ratings in this way looks like an effort to cultivate the belief that the risk associated with sovereign debt is unrelated to how sovereigns behave. Governments have created their own difficulties by mandating reliance on credit ratings and, through an elaborate inspection regime for credit rating agencies, implicitly signing off on the quality of credit ratings. Government endorsement of credit rating agencies should be ended, and credit rating agencies, along with everyone else, should be able to offer freely their opinions about the likelihood of a sovereign debt default.

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The Western Hemisphere is engaging in a very dangerous economic exercise. It is called debt accumulation. The old time Keynesian argument was that "debts don't matter because the government never has to pay it off, and can tax and print money." Is this true? So far, so good. The entire debt of the US, UK and Eurozone is $100 trillion, give or take. The central banks are locked into a position where interest on the debt can never be allowed to go above 1% or so. This means endless printing of money.

If Bernanke and the Fed weren't buying up 75% to 90% of the US Treasuries, the interest rate on them would be north of 4% or 5%, maybe 7% or 8%. Then the politicians would have to pay attention to spending. The market would force it. But they are getting a free pass and can avoid addressing the issues.

Now it is like a perpetual monopoly game where one player has all the hotels, and the bank is issuing everyone free $100 bills to keep the game going. All the money will end up with the hotel owner. And the gap between rich and poor continues to expand. All done in the name of "caring for the little people."

In view of that, I am not sure what a rating by credit agency means. Or what a downgrade means.

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Rafael Mangual
Project Manager,
Legal Policy

Katherine Lazarski
Manhattan Institute


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The Manhattan Insitute's Center for Legal Policy.