"Des waerelds doen en doolen, is maar een mallemoolen,"

"Des waerelds doen en doolen, is maar een mallemoolen," engraving from Het Groote Tafereel der Dwaasheid, 1720.

"The actions and designs of the world go round as if in a mill." South Sea bubble financial crisis.

Monday, April 25, 2011

The added value of rating agencies

The S&P alarm on US debt on April 18th moved stocks markets and triggered a lot of comments. The recurring ones are about the added value of Credit Rating Agencies (CRAs). The very existence of CRAs is being questionned every time financial news put them in the front row because it still not clear whether or not they passed a “market test”. Do they provide any extra information?

If the added value of CRA’s in the US is still a questionable, no wonder the rating industry has suffered a lot of criticism with regards to applying ratings to developing economies, especially after the Mexican and Asian crises. Ratings could indeed favor procyclical behavior or could be sticky, in that they would simply react to macro-economic parameters or market news, reinforcing arguments which claim they are, evidently, behind the market, since they use publicly available data. For Powell

while the rating agencies do not necessarily add to the sum of underlying knowledge, they change the degree of “common knowledge”. In other words, each analyst may have known what S&P knew, but they did not know for sure what all the others knew. All are now sure that at least all know S&P’s views.

So S&P issued a “warning” on US debt, stock markets then plunged and I am still wondering how information is treated where it matters. Because, as Krugman noted, the 10-year bond rate did not seem to integrate the S&P signal.

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