Moody's self-fulfilling prophecy makes the case for junking ratings agencies

COMMENT:Junk status means the distance between here and creditworthiness is all the greater, writes DAN O'BRIEN,Economics Editor

“INCOMPREHENSIBLE” WAS how the European Commission in Brussels described Moody’s downgrading of Ireland to junk status at market close on Tuesday. Unprintable descriptions of the move were uttered across Dublin.

As sure as night follows day, the junking caused a further sell-off of Irish Government debt across all maturities from the moment markets opened at 8.30am yesterday.

By 10am the yield on the benchmark 10-year bond had risen by 30 basis points (0.3 percentage points).

A plateau was reached before another 30-point rise took place in the last hour of trading – though the end-of-day move was more likely to do with euro zone-wide wobbles that saw all the weak peripherals lose ground.

But, interestingly, the contagion only went one way. Ireland’s downgrade appeared to have no effect on the other Piigs (Portugal, Ireland, Italy, Greece and Spain). Yields on their governments’ paper fell in early trading.

Ireland is once again the second most likely of the Piigs to default, having briefly lost that dubious honour to Portugal in recent weeks. The yield on the 10-year bond hit 14 per cent by the end of the day.

If its 60 basis point rise was bad, the 160 point increase on the one-year bond was much more pronounced. It closed at 11.8 per cent last evening.

In immediate and concrete terms, this doesn’t matter. Having been bailed out, market interest rates are irrelevant for the State’s funding position. Taxpayers won’t pay more to service debt as a result of the downgrade and bond sell-off.

But junk status and the uptick in yields both mean the distance between here and creditworthiness is all the greater. It will take all the longer for the State to fight its way back into the bond market.

Moody’s got a kicking from just about everyone yesterday. It was deserved.

Ratings agencies underestimated sovereign risk during the good times. Now, the main and justifiable criticism of them is the timing of their downgrade decisions.

Time and again during the crisis they have exacerbated matters by cutting ratings at moments of acute fragility. With a feeling of endgame pervading the euro zone over the past week, Moody’s lived down to the ratings agencies’ bad-timing reputation on Tuesday.

There is an even bigger criticism of ratings agencies, which Moody’s decision on Tuesday exemplified.

They do not improve market functioning. If anything they impair it by lessening investors’ incentive to spend the time and money doing their own risk analysis. Ratings agencies amplify the well-recognised herding problem in financial markets.

The self-fulfilling nature of their prophecies was to be seen with the Moody’s decision. It cited as one of the reasons for the downgrade as the likelihood that Ireland will need a second bailout. The downgrade and resulting rise in yields yesterday have increased the probability of a second bailout.

There are very serious problems in almost every aspect of the structure and functioning of the financial system that has evolved in recent decades. Credit rating agencies are one of the many problems.

Although anyone with a liberal bone is his body instinctively recoils from banning seemingly legitimate enterprise of any kind, there is a case for outlawing hawkers of credit ratings.