Rating Agencies have become increasingly important over the decades, slowly but surely penetrating the “market” system and strongly influencing it.
Their importance has increased exponentially since the Eighties, as the development of financial markets reinforced the need for investors to have external support such as Ratings for the need to perceive the size of the reliability of individual issuers.
From this point of view, the Agencies constitute an indispensable infrastructure, capable of expressing the unit of measurement of risk.
And the spread of increasingly frequent and severe financial crises has almost always involved global Agencies, which have often – unfortunately – been part of the problem rather than part of the solution.
The growing instability of finance
Since the mid-Thirties, after the 1929 Great Crisis, all developed countries have had regulatory references for achieving and maintaining financial stability.
But only after the Second World War this picture was completed at the international level through the definition of the new monetary order centred on the “Dollar”, definitively abandoning the “Gold Exchange Standard” system, which consisted in considering that the Dollar was the reserve currency, i.e. the only currency that could be converted into gold.
It is high time we cleared the field of attempts to consider the current global financial crisis as caused by the strong turbulence in the sub-prime mortgage segment and consider it as an isolated crisis.
In reality, financial innovation, deregulation, and globalization have gradually introduced elements of inconsistency into the original regulatory framework, generating fertile hinterlands to isolated financial crises but, above all, to the current one.
The intervening lack of the anchor of the Gold Exchange Standard was the main cause of the serious crisis in Latin America in the early Eighties, generated by the generous loans that international banks had given to those sovereign debtors allocating the surplus of oil-producing countries after the price of crude oil had tripled in the Seventies.
Similar reasoning could apply to the mega-corporate failures of the beginning of the new millennium.
The recent and current epochal crisis, only triggered by the turbulence in the sub-prime mortgage segment, could and should make us feel the need for a more stringent regulation and make us understand how to avoid making the same mistakes in the future.
This concern, to a large extent, the Rating Agencies in particular, which were not only witnesses to this financial instability but above all protagonists.
It is, therefore, necessary to start from an analysis of the Agencies’ errors (deliberate and unintended) in systematically underestimating risks in various pre-crisis situations.
Private risks and systemic risk
Systemic risk is the risk of the collapse of an entire financial system or market.
It can be triggered by a wide variety of events, from mass psychological influences to the behavior of financial intermediaries.
In this case, the failure of a single entity in the financial system can cause cascading failures, leading to the collapse of the entire financial system.
An example of systemic risk is the so-called “Bank run” of a bank that causes cascading effects on other banks resulting in a cascade liquidity crisis in a scenario of general panic.
Moreover, liquidity problems may be greater the higher the level of indebtedness of financial intermediaries, so that the failure of one participant may create liquidity problems for the others and, as a domino effect, expose the whole market to systemic risk.
Now, given that the basic models of finance are based on the assumption that private and sovereign risks are correlated, it should be pointed out that this assumption is difficult to bear in mind that when the inevitable interventions of the States to save the Banks have determined at the same time a reduction in the risk of default for the banks but an increase in the risk of default by the State and therefore an increase in systemic risk.