U.S. credit rating firms due for a shake-up

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This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.

In an article dated July 12, I first reported that Dagong International Credit Rating Co., the largest credit rating agency of China, had stripped the U.S. and some other Western nations of the AAA ratings given by its big three Western counterparts. Dagong also accused its Western rivals of not properly disclosing the repayment risk and causing the global financial crisis and current debt crisis in Europe.

This week, Guan Jianzhong, chairman of Dagong, made some more follow-up comments. In an interview with Financial Times, Guan further criticized the three dominant global credit firms – Moody’s, Standard & Poor’s and Fitch – for having become politicized, “too close to the clients”, and highly ideological, thus losing their objectivity.

As if to confirm the Chinese slam (not their intentions, I’m sure), WSJ reports today the U.S.-based big three have made an urgent new request to their clients: do not use our names on bond issues.

Why? Because the new Dodd-Frank financial reform law makes the agencies liable for their ratings, effective immediately. So, instead of defending and standing behind their work, Moody’s, S&P and Fitch essentially telegraphed this message to the world − “China is right – do not trust us”.

The big three credit firms have been highly criticized in the aftermath of the global financial crisis. However, due to the lack of competition, their upgrades and downgrades still impact the markets considerably. Furthermore, in what appears to be a joint effort to remain relevant, the big three seem to have got into the habit of issuing downgrades right in the middle of trading hours, distressing the markets and investors.

Feeling victimized by them, the European Union (EU) had announced that it would set up its own ratings agency. A recent Xinhua editorial also noted:

“To reform the West-dominated international financial order, more credit rating agencies should be set up in non-Western countries to break Western monopoly over the global credit ratings.”

China, the largest sovereign debt holder of the world, with a record 2.454 trillion dollars at the end of June, undoubtedly would like to have a bigger say as to the risk and reward Beijing deems appropriate for its investment. In that regard, we pretty much know Beijing’s thoughts, judging from the sovereign credit ranking issued by Dagong, which in many ways contradict that of the big three.

With China’s growing influence on the global stage, credit ratings coming from China should be expected to win greater recognition over time. The new “revelation” by the big three will most likely only help this evolution along.

The ongoing global financial crisis has prompted some seismic shift in almost every industry. The credit rating services somehow seem to have escaped unscathed and are definitely long overdue for a major shake-up or two.

Source: Dian Chu, Economic Forecasts and Opinions, July 22, 2010.

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