Credit agencies and taxation without representation

The Financial Times Lex Column discusses on March 11 Moody’s decision to cut the Spanish sovereign debt rate (“Spain downgrade”). As the article points out, one of the consequences that such a decision implies is that “the cost of the capital required to put into the cajas will be commensurately higher”. This increase of borrowing costs will offset tax increases and savings in public services decided by governments and parliaments (Central and Regional’s) in Spain; taxes and savings that have direct effects on the citizen’s lives. Days before, we assisted to the Greece downgrade and today, March 16, to Portugal’s one.

On March 11 too, the economic affairs commissioner, Olli Rehn, and the commissioner in charge of financial services, Michel Barnier, said in a joint statement that «The last few days highlight once again how important (is) a more and better regulated environment for ratings,» (..)»Our services are now working as quickly as possible» on a package of reform proposals, «due before the end of the summer.»

I think that the ratings agencies’ decisions involve some political consequences that deserve some additional comments. This transfer of resources from taxpayers to bond investors seems to me a contemporary version of the classical “Taxation without representation”. As we know, in his negative version: “No taxation without representation” was the slogan originated in the 1750s and 1760s. It summarized an essential grievance of the British colonists in the American colonies that qualified as unconstitutional the laws taxing them approved in the distant Westminster’s Parliament. In the present case, no Parliament has approved the measure. A resolution adopted by a private enterprise on supposedly technical basis has produced such an effect.

As professors Costas Milas (Keele Management School, Keele University, Staffs, UK) and Theo Panagiotidis (Lecturer, University of Macedonia and Visiting Research Fellow, Hellenic Observatory, London School of Economics and Political Science, UK), highlighted in a letter to Editor in the same newspaper and day: Recent academic work published by the  International Journal of Finance and Economics suggests that the credit decisions made by the three main credit rating agencies (Moody’s Investors Service, Standard & Poor’s and Fitch Ratings) are affected by the following economic factors: per capita gross domestic product, GDP growth rate, government deficit, public debt, amount of foreign exchange reserves and the country’s history of default. According to the research, the above economic factors explain up to 40 per cent of the decisions made by the credit rating agencies leaving the majority of their decisions unexplained (…)”

On other words: there’s a big slice of opacity in these decisions.

If shareholders in rating agencies can invest in the bond’s market and can get gains from downgrades, some questions could arise on the neutrality of their decisions. A financial system cannot run smoothly when a shadow of doubt darkens rating decisions. One thing is to kill the messenger and other let the messenger kill you. The case for a reform in depth of rating agencies is urgent. The sooner, the better.

Dr. Enric R.Bartlett Castellà
ESADE Law School (URL).

Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies

Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL On amending Regulation (EC) No 1060/2009 on credit rating agencies.COM (2010) 289

 Seguimiento interinstitucional del documento COM (2010) 289

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