Roger E. A. Farmer is Distinguished Professor and Chair of the Economics department at the University of California Los Angeles (UCLA).
Why do the ratings agencies whip sovereigns for deficits and debt in a weak economy, but not warn the big banks to fund their activities with excessive leverage?
The three principal ratings agencies, Moody’s, Standard and Poor’s and Fitch are profit-making enterprises. During the recent financial crisis all three of these agencies failed to recognize the risks involved in holding large portfolios of mortgage backed securities. It is certainly true that the investment banks profited from the securitization of risky loans that were rated AAA. But I do not think that there was collusion or fraud involved.
The most likely explanation for the failure of the agencies to recognize the systemic risk involved with mortgage backed securities and credit default swaps is the pace of innovation in the derivatives markets. Analysts at the ratings agencies had a hard time keeping up. The best and the brightest minds were not employed by the agencies. They were busily involved in the process of inventing new and exotic securities.
Why are the agencies now “whipping” sovereigns for deficits and debt. There I think it’s a case of “once bitten twice shy”.