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Europe Declares War on American Ratings Agencies

Not all politicians in Europe agree, and some have warned that attacking the ratings agencies was a ploy aimed at distracting attention away from deeper structural problems in European economies. Kay Swinburne, a British member of the European Parliament, said: “The EU seems determined to find scapegoats for the current crisis. The problems in the eurozone are predominantly as a result of poor fiscal policies of some EU governments, not because of the decisions of ratings agencies to downgrade them.”

Sharon Bowles, the British chairman of the European Parliament’s Economic Affairs Committee, has also warned against demonizing the rating agencies: “They are being shot as the bringer of bad news. I am not entirely convinced that the [rating] system is broken,” she said.

To be sure, many analysts say the rating agencies deserve much of the criticism that they have received over the past several years. By giving investment grade ratings to American sub-prime mortgage debt, the ratings agencies helped bring about the international financial crisis that the world is still recovering from.

But others say that because of these earlier failings the rating agencies have become more proactive in warning investors of risks facing the financial markets. To rein them in now because they are increasing investor awareness about just how troubled the finances of countries like Portugal, Ireland, Italy, Greece, and Spain have become would be a giant step backward.

Wolfgang Franz, the chairman of the German Board of Economic Advisors, told the Frankfurter Allgemeine Zeitung newspaper that the ratings agencies should be applauded for doing the job they are supposed to do: “Of course the rating agencies failed in the run up to the subprime crisis. But then one should not complain that the agencies are pointing out heightened default risks in government borrowing.”

The ratings agencies, which fear their brand names could be damaged by any suggestion that they are caving in to political pressure, have pushed back hard against the criticism.

For example, the head of S&P in Germany, Torsten Hinrichs, recently defended his record on German public television. He told viewers: “The assertions are completely made up out of thin air and factually wrong. They are either based on ignorance of the facts or are politically motivated comments that neglect the facts. There are about 100 ratings agencies in the world. The importance given to the big three stems from the fact that they have proven to be accurate in their ratings” over a period of many years. Hinrichs added that S&P will not put 150 years of credibility on the line “to enable politically motivated push-ups” of Greece.

Steven Maijoor, the Dutch head of the European Securities and Markets Authority, a pan-EU markets watchdog based in Paris, said Europe wants to break the monopoly currently held by the major American ratings companies, and enforce its own operating regulations. “We shouldn’t blindly adopt the regulatory system of a third country,” Maijoor told the Financial Times Deutschland.

But apart from public posturing, it remains unclear as to what European politicians can really do to limit the influence of American ratings agencies. International investors are unlikely to put much faith in an Orwellian-like European ratings agency that is funded by the state and created for the sole purpose of providing European countries with ratings that are more favorable than the ratings assigned by its American competitors.

In case there is any doubt, there are myriad examples of what a politically managed EU ratings agency would look like. For example, while the big three U.S. credit rating agencies downgraded Greek debt to “junk” more than one year ago, Germany’s Euler Hermes ratings agency currently gives Greece their top AA rating, citing the country’s “very strong business environment.”

Another example involves the European Banking Authority (until just recently it was known as the Committee of European Banking Supervisors), which in July 2010 stress-tested European banks. It concluded that the Bank of Ireland and Allied Irish Banks were capitalized to meet even the most adverse of scenarios. But just a few months later, the two banks needed €18.5 billion of new capital to remain afloat.

European policymakers are now drafting laws designed to curb the ratings agencies by increasing their legal liability, among other things. But a proposal to make the agencies legally liable if a downgrade of a country turns out to be incorrect is facing conceptual problems: officials have yet to come up with a clear definition of the word “incorrect.”

In any case, the new laws are not expected to be in place until the end of 2012. By then, Europe’s financial fate may already have been decided.