Sunday, 10 July 2011

EU planning to censor international credit rating agencies

The EU Commission is planning a crackdown on the international credit rating agencies after they downgraded Portugal's credit rating the other day.

By dropping a country's credit rating, it makes it more expensive for that country to raise money through selling bonds.  Government bonds are basically promises to pay a certain amount of money on a certain date - it's effectively a government asking for a loan without any monthly repayments.

The lower a country's credit rating, the higher the amount of interest investors will want because there's a higher risk they won't get paid.  It's just like when you take out a credit card - they have a headline interest rate that you will get if your credit rating is good but if it's bad you'll end up paying a higher rate.  And if your credit rating is awful then you have to go to the kind of high risk lender that advertises on low budget satellite TV channels.

A country's credit rating doesn't matter so much unless it's trying to raise money from selling bonds, like eurozone countries are right now.  The downgrading of Portugal's credit rating a few days before it was due to issue billions of pounds worth of new bonds will cost the Portuguese government a lot of money.  Instead of paying €1.04 for every €1 of bonds they sold two years ago, they're now going to have to pay at least €1.11.  It's only 7 cents but if Portugal issues €5bn in 10 year bonds, they will have to find €5.55bn when they mature in 2021.  They haven't got €5bn now, it's a big risk to assume that they're going to have €5.55bn in 10 years time.

Obviously the amount of money eurozone countries have to pay to borrow money, the less chance there is the euro can be saved so in desperation the EU Commission is preparing new laws to stop international credit rating agencies from giving bad news about EU countries.  As with many new laws that come from the EU, this one is based on a fundamental misunderstanding of what's happening in the real world.
It seems strange there is not a single rating agency coming from Europe. It shows there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe.
- Emperor Barroso, President of the Imperial Commission
Fitch Ratings and Fitch Solutions, as well as Algorithmics, a leader in enterprise risk management solutions, are part of the Fitch Group. The Fitch Group is a majority-owned subsidiary of Fimalac, S.A., headquartered in Paris, France.
Far from helping eurozone countries, this will increase the risk of investing in government bonds from EU countries.  If they can't get accurate information about the risk of an investment then investors will steer clear of eurozone bonds or demand even higher interest rates to protect themselves from unknown risks.