There was a time when the credit upgrades/downgrades from the major rating agencies were held as gospels of truth. But the most credible were those from Standard and Poor’s or S&P, the world’s biggest rating company. A country or a company would complain in silence after being given a junk rating. Or would go into endless bouts of celebrations after a credit upgrade. The ratings, however, went on unquestioned and unchallenged.
The influence of the rating agencies was such that presidents and prime ministers, those obsessed with being called technocratic reformers, often touted credit upgrades as the by-product of their reformist bent. Leaders across the globe who relentlessly chased nice charts such as GDP growths and credit upgrades became slaves to the ratings of S&P and its ilk.
What leader would not give up a finger to get a Triple A rating from these supposed wise and fair institutions?
That was then. Today, a country with an economy as large as the US can get a credit downgrade—then get the reverse effect: better borrowing terms on a sustained basis. A downgrade a few years back on its creditworthiness was shrugged off by the US and the ultimate black eye was on the rating agencies. But the flawed country assessments were minor compared to the mountain of woes that the rating agencies face today.
According to suits filed by the US Justice Department, 19 states, the District of Columbia and California pension fund Calpers, the S&P gave top ratings to risky subprime mortgage bonds, which default led to the Great Recession in 2008. Despite warnings from analysts that the top-rated securities were either risky or junk, the top management of S&P still gave Triple A ratings to these risky bonds. The Justice Department said the mortgage giant lied to protect its clients but helped wreck havoc on the broader economy in the process.
In short, S&P was part of the wrecking crew that nearly pushed the global economy somewhere near the Great Depression. It failed as a wise and fair judge of sound investments.
After two years, the S&P recently settled the suits with a $1.35 billion payment to the US government and a $125 million payment to Calpers. The settlement cleared S&P of any or all criminal violations buts its initial swagger—and its position that the suits were related to the downgrade it had issued on US bonds—was gone.
Replying to the charges that it made bad calls to protect clients and harm the public, S&P admitted that its claims of objectivity did not constitute fraud as these were mere “puffery” that were standard in marketing.
The S&P also settled a case with the Securities and Exchange Commission, this time involving a 2011 inflated rating it gave on another mortgage-backed security. S&P paid a fine of $80 million on top of accepting a SEC-imposed 12-month ban which prohibits the rating giant from engaging in some branches of securities rating.
The issue of bad judgment made by the biggest CRA in the world would not have been relevant to the Philippine context were it not for one thing—the Aquino administration’s frequent basking in the glory of credit upgrades from the likes of S&P. In fact, were we to track the sources of pride of Mr. Aquino, these are easily the top three : GDP growth, credit upgrades and the approbation of the Davos crowd. Plus, of course, the puff pieces from foreign financial journalists who visit the country for a day or two, then write glowing pieces on the supposed economic miracles taking place in the country.
I will qualify the Davos crowd approbation. Praises from the Davos crowd and applause from the Makati Business Club. You must have seen the swagger of Mr. Aquino during the visit of Klaus Schwab.
As citizens, we appreciate those upgrades. You feel good when the country’s borrowing rates are the lowest that the market could offer. It is cheaper to undertake much-needed infrastructure projects such as roads and bridges, seaports and airports. Lower borrowing costs, though there are exceptions (troubled Spain borrows cheaper than steady UK), reflect on the economic health of the borrowing country.
There is everything to like about a country borrowing at the cheapest rates available.
The S&P’s $1.5 billion in payment for bad calls made prior to the Great Recession, which was documented in internal e-mails of S&P analysts that warned of a house burning down, plus the SEC–imposed fine and one year ban, raise serious questions about the S&P’s rating calls. What was more alarming was its admission that it resorted to “puffery” to attract clients.
The S&P actuations and conduct make these questions relevant. Were its upgrades on the Philippine creditworthiness for real? Or, were these upgrades made to serve the purpose of puffery?
If the S&P can rate dross as gold and claim that the ratings were a normal business practice, what can prevent it from hyping up the credit standing of countries that take immense pride in upgraded ratings, especially a country with a rating-obsessed leader such as Mr. Aquino? The Philippines under Mr. Aquino has been obsessed with this kind of paper chase – nice GDP charts and upgrades from the major CRAs.
If it wants to, it is quite easy for S&P to just turn a blind eye to certain flawed fundamentals and highlight the areas of strength to justify a series of upgrades.
Just like what it did in 2007 and 2011 to mortgage-backed securities in the US.
I do not know if Mr. Aquino would place less emphasis on credit upgrades the next time he speaks on the health of the Philippine economy. If he does not, such boasts on the string of credit upgrades will have a hollow, phony ring.