THE REAL POWER of credit rating agencies has caused ripples in the international financial markets, so much so that we are hearing loose talk of a global financial Armageddon.
It is not merely investors who recoil at debt downgrades. A few years ago the Japanese government took an unprecedented step of summoning a Moody’s representative before a Lower House Committee to explain why the agency cut its credit rating.
Such is the effect of a downgrade. The Barbados Government recently attempted to shrug off a downgrade as a minor economic irritant, but it could have far-reaching consequences unless there is some improvement in the economic performance in the short term.
At the international level, the Greek debt crisis has prompted questions about whether the euro can survive without a return of what is now an unimaginable centralization of fiscal policy within Europe.
There is a simpler way. Many economists and financial analysts believe that irresponsible borrowing by governments in international credit markets is supported by irresponsible lending. Some say that bank regulators should just say no to such lending by institutions under their purview.
There is no doubt that lending to foreign governments is in many ways inherently riskier than unsecured private debt or junk bonds. Private borrowers often have to offer collateral which limits the lenders’ downside risk, and the fear of losing the pledged assets encourages borrowers to act prudently.
Governments on the other hand, offer no collateral for their loans, and their principal incentive to repay – the fear of being cut off by international credit markets – derives from a perverse addiction to deficit financing and an ungrained reluctance to rein in spending.
Commercial debt usually has covenants that limit the borrower’s ability to roll the dice. Loan or bond covenants often require borrowers to agree to maintain a minimum level of equity capital or cash on hand. Government bonds, on the other hand, have no covenants.
Similarly, private borrowers’ loans could be “called” if they misrepresent their financial condition to secure bank loans. Securities laws require that issuers of corporate bonds outline all possible risks. By contrast, governments pay no penalties for overstating their financial positions, as the Greek debacle shows.
When private borrowers default, bankruptcy courts supervise a bankruptcy or reorganization process through which even unsecured creditors could hope to recover something. But there is no process for winding up a state and no legal venue for renegotiating its debts.
The power to tax is thought to make government debt safer but the power to tax has practical limits, and governments’ moral or legal right to bind future generations of citizens to repay foreign creditors is always a hot political issue.
However, the real problem is that bad ideas move easily across borders, and misguided economic notions on both sides of the Atlantic have been reinforcing each other. The same will be true of the economic stagnation that those policies will ultimately bring to these countries.
