The European Parliament is considering giving the European Union substantial authority over rating agencies including the right to ban sovereign credit ratings if countries don’t want them. In a related development, the parliamentarians are also considering giving schoolchildren the right to ban unsatisfactory report cards. The underlying philosophy is relatively simple: if something is unknown; it does not exist.
This philosophy is, of course, different from “what you don’t know won’t hurt you.” Excessive government debt especially excessive hidden government debt will absolutely hurt you if you either buy it or have to pay it back. The only people who are not hurt are those who borrow the money and spend it getting themselves reelected. Curiously, such people sometimes serve in the European Parliament.
Here is the basic calculus on bond ratings. There are three groups of players.
First, there are those called rating agencies who, in recent years, have been found wanting in their analysis. In other words, they are perceived not to do the job very well.
Second, there are those called institutional investors including banks, insurance companies, pension plans, hedge funds, mutual funds and so forth who are essentially too lazy to do the credit analysis job at all, so they prefer to rely on those who merely do not do the job very well.
Finally, there are those called countries that really don’t mind very much if the job is not done very well as long as it makes them look good, but they do object when the job is not done very well and it makes them look bad.
Since the countries get to make the rules, the simple solution is to keep those who do not do the job very well from doing it all. When it makes them look bad. As it does now.
In the past, the institutional investors have been more or less free to buy or not buy government bonds as they saw fit. This was the leverage that gave rise to the famous James Carville quote about reincarnating as the bond market.
Imagine a scenario in which institutional investors say to themselves and each other “we really have no idea what’s going on with these borrowers so we are just not going to participate at all.” Then, those who borrow money and spend it getting themselves reelected might actually have to do their jobs and come up with viable financial systems for running their countries.
At that point, watch for the European Parliament to consider legislation requiring institutional investors to buy their bonds. The legislation would also include the reinstatement of report cards though only A’s would be permitted.