Credit-rating agencies play big role in Europe's drama

The rating agencies that sort good investments from junk are once again injecting fear into financial markets.

Only this time it's for warning investors about a possible threat - Europe's debt crisis - rather than for failing to see one coming.

Why do their words carry so much weight?

These are the same firms that gave safe ratings to high-risk US mortgage investments that later imploded and caused the financial crisis.

Those failures raised doubts about how much the assessments of rating agencies such as Standard & Poor's, Moody's and Fitch Ratings are really worth.

Yet less than two years after the crisis peaked, investors still take them seriously. Case in point: S&P on Wednesday cut Greece sovereign debt to "junk" status and dropped Portugal's down two notches.

That downgrade sent financial markets from London to Hong Kong plunging.

Investors feared that more European countries would be dragged into the region's debt debacle. In the US, the Dow Jones industrial average sank 213 points on Wednesday before recovering on Thursday - the same day S&P downgraded Spain one notch.

A big reason the agencies still carry influence is that many institutional investors - from central banks to pension funds - require safe ratings on the debt of countries, firms or securities they invest in.

A downgrade from S&P or Moody's might not tell investors anything they don't already know. But it can force a central bank or investment fund to shed the downgraded investment. That's why it can roil financial markets.

If Moody's follows S&P and downgrades Greece to junk, the European Central Bank, under its rules, could no longer accept Greek bonds as collateral in lending to Greece.

It would become harder for Greece to roll over its debt into new loans. Fears of a spreading debt crisis would grow.

That doesn't mean Wall St bows to the assessments of rating agencies.

"I totally ignore the ratings agencies - to a point," said Andy Brenner, head of emerging markets at Guggenheim Securities.

He said ratings agencies tend to act too late. Greece's debt, Brenner noted, has been trading at junk levels for weeks.

Brenner pointed out that Brazil, Mexico and Russia have credit ratings similar to or worse than Greece's. Yet 10-year notes for Brazil, Mexico and Russia yield around 5 per cent. By contrast, Greece's 10-year notes offer around 10 per cent.

That means investors view them as twice as risky.

Some analysts say the rating agencies have a better track record at rating countries' debt than complex debt investments like mortgage securities.

"It's much easier to understand their metrics when it comes to downgrading countries," says Andrew Busch, a currency strategist at BMO Capital Markets in Chicago.

Those metrics include how much tax revenue the country is using to pay down its debt and how fast its economy is growing.

Still, Busch said rating agencies sometimes surprise investors. S&P's downgrade of Portugal, for instance, had a bigger impact on the market than its downgrade of Greece because investors weren't expecting it.

"That gave the flavour of contagion and that's what bothered people," he said.

EU spokesman Amadeu Altafaj Tardio said on Wednesday: "Who is Standard & Poor's anyway?"

He said the agency should better assess "realities on the ground", such as financial rescue talks in Athens.

- AP