Don't take revenge on the raters for sovereign downgrades

The US Justice Department’s lawsuit against Standard & Poor’s (S&P) over subprime structured finance ratings, launched in February 2013, leaves many unanswered questions. Not least, why has it taken so long to act since the mass downgrades of subprime securities in 2007?

Neither of the other large agencies, Moody’s and Fitch, has yet been charged. And while all three had a commercial incentive to keep the subprime bandwagon rolling, none earned anything close to the fees generated by the investment banks who were packaging the securities themselves.

So far, only one bank has faced a major enforcement action (as opposed to compensation claims): Goldman Sachs agreed to pay $550m in 2010 to settle a threatened prosecution over 'incomplete information' supplied to investors in the Abacus collateralised debt obligation (CDO). That sum is little more than one-10th of the $5bn demanded from S&P.

This leaves the suspicion (erroneous as it may be) that the ratings agency is being targeted for another reason entirely. S&P is the only one of the big three agencies to have cut the AAA rating on the US.

That suspicion is equally prevalent in Italy, where a prosecutor is seeking to launch a case against S&P and Fitch for allegedly trying to “manipulate the market” by leaking information prior to downgrades of Italy in 2011. Magistrates in the main commercial centres of Rome and Milan rejected the case, so it will now be heard in the southern tourist resort of Trani (population 50,000).

To date, the only known leaks prior to ratings actions have come from the sovereigns, rather than the agencies. When S&P downgraded nine eurozone sovereigns simultaneously in January 2012, European Commission officials openly began briefing journalists before the new ratings had actually been published.

Governments often criticise ratings downgrades, but this is the first time that they appear to be taking regulatory retaliation. Any future ratings actions on Italy or the US will occur under the shadow of very public lawsuits, undermining the credibility of the whole process.

Today’s policy-makers should remember the response of then finance minister, Domenico Siniscalco, when Italy was downgraded in 2005: “We are paying for political uncertainty and we must react.” If his cabinet colleagues had listened to him, Italy’s ratings might be rather higher than they are today. The best reaction to a downgrade is to heed the message, rather than shooting the messenger.