What Are Ratings Agencies For?

By Megan McArdle

There's no question that the credibility of the ratings agencies has been called into question by the performance of the enormous amount of toxic sludge that they rated AAA during the housing bubble.  So I do understand the complaints that they're still around, influencing markets by what they say, without having ever really explained very well how they got it so monstrously wrong in the first place.

However, I don't really understand this complaint:

I think that's basically a reference to the rating agencies -- it's not the most clearly written piece, though it makes up for that with passion. Anyway, he's right: the rating agencies, and in general the poo-bahs of finance, brought this crisis on the world -- and are now solemnly lecturing nations about the evils of the deficits incurred mainly to fight the crisis.

I don't really read Moody's, et al. as "lecturing" anyone about the evils of their deficits. Moody's job is not to make countries into better, more fiscally responsible people.  It's to advise people about the risk of default of the bonds they might buy.

Does anyone think that Ireland's current deficits--along with its other problems--don't make the country more likely to default?  Or Greece, or Italy, or any other country or firm?  The more money you borrow, the more likely you are to become unable to repay it--especially the new debt.

Now, Paul Krugman might say that by borrowing money to stimulate the economy, you can actually make default less likely, compared to an alternative universe if you didn't.  So perhaps Moody's is wrong--though I don't see even Paul Krugman actually making this argument much any more.  Most people seem to have switched to arguing about the suffering that can be averted with stimulus, which seems more sensible to me; for stimulus to pay for itself, in terms of tax revenue, it needs to have a really sizeable multiplier.

But being wrong is not the same thing as delivering moralistic "lectures" on the evils of debt.  Maybe Moody's shouldn't exist any more, but I don't think the big problem is that they're noting the pretty uncontroversial proposition that countries with higher debt loads are more likely to default on their debt.  It's not like the markets can't figure out that one on their own--indeed, my perception is that the ratings agencies are usually following the market, not leading it.

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