Amid the noise and haste of the present volatility, it may be instructive to reflect on the thoughts of Charlie McCreevy. The Commissioner in charge of the EU’s Internal Market and Services may be a highly experienced Eurocrat but he hasn’t forgotten his accountancy roots. Speaking to the European Parliament’s Economic and Monetary Affairs committee, in the middle of last month, he drew preliminary lessons on the consequences for Europe of the US sub-prime mortgage crisis. The rating agencies, perhaps predictably, came under renewed fire. The criticism is simple. They stand accused of being slow to downgrade their credit rating, and of relying on a weak and poorly explained methodology. McCreevy also suggested that the ratings agencies face a “potential conflict of interest”.
On the one hand, credit rating agencies provide objective ratings to investors in asset-backed securities; on the other, they provide advice to banks on how they should structure their lending to get the best rating. At the same time the agencies’ ratings are used as a basis for the calculation of banks’ regulatory capital. Genuine and longstanding concerns exist in government circles over the tangled web the agencies seem to weave, their role and their power.
But while few may take issue with the argument that the role of credit rating agencies could be clearer and that they could do better, perhaps we should be careful not to shoot the messenger. Harking back to a previous crisis, McCreevy said that a common theme ranging from Enron to Parmalat to today’s crisis was the use of off-balance sheet entities. He wants to address with supervisors the adequacy of risk appreciation and oversight of such vehicles.
The crisis was born out of risky loans being repackaged and sold on to institutional investors, at least some of whom did not appear to fully understand the nature of the underlying risk. Putting these assets in offbalance sheet structures may have blinded many managers in financial institutions to the underlying risk inherent in these securities, particularly in a crisis. Did the supervisory authorities have, in their turn, a sufficient overview of the links that a parent institution might still have with an off-balance sheet vehicle? How robust have the internal models used by risk managers been in the extreme liquidity crisis of recent weeks? Renewed interest in special purpose vehicles seems inevitable and justified.
For many corporates as well as consumers, until recently these would have been academic questions. Now such questions seem to be relevant but as yet unanswerable. What is clear for treasurers is they are operating in a new era where, for the moment at least, confidence has waned and uncertainty has increased.
PETER WILLIAMS
Editor
