The recent downgrade of the United States sovereign credit rating by Standard and Poor’s (S&P) has left many people speechless.
Nobel laureate Paul Krugman has likened S&P’s attitude to that of “a young man who kills his parents, then pleads for mercy because he is an orphan”. S&P and its sister rating agencies, he says, have played a major role in causing the current budget crisis in America by blessing mortgage-backed assets that later turned out to be worthless. Another Nobel laureate, Joseph Stiglitz, has viewed credit rating agencies as one of the key culprits in the 2008 global financial crisis.
The bipartisan Financial Crisis Enquiry Commission of the US Congress has concluded in its report: “The three credit rating agencies were key enablers of the financial meltdown … the mortgage-related securities at the heart of the crisis could not have been marketed without their seal of approval.”
According to US Treasury Secretary Timothy Geithner, S&P showed “terrible judgement” in lowering the US government’s credit rating. “They’ve handled themselves very poorly. And they’ve shown a stunning lack of knowledge about the basic US fiscal budget math,” he adds.
Amid such widespread distrust of the rating agencies, how come global financial markets have reacted in unison and so violently in response to the downgrade by S&P?
Generally speaking, how have financial interests – whose interests, after all, S&P represents – gained such power over even sovereign governments like the US?
The first step, says Manchester Business School’s Ismail Erturk in his book Financialisation at Work, was when Western countries, starting with Britain and the US, moved from a defined-benefit pension scheme for their workers to defined contribution schemes. This meant that vast pools of capital, representing the savings of working people in these countries which add up to 100 to 200 per cent of the two countries’ GDP, soon came looking for higher returns from the bond and equity markets.
The second step started in the 1970s, says Peter Hall (in the same book), professor of Government at Harvard University. The British government, almost bankrupted by the demands of the British public-sector trade unions, started borrowing heavily from the financial institutions in the City of London. To facilitate such extensive borrowing, the British government decided to use the Bank of England’s minimum lending rate as the controlling lever. This, says Professor Hall, had the unintended effect of making the buyers of government bonds act in cohesion — they would either buy government bonds together or hold off together till conditions became propitious. They realised that the more they held back, the more desperate the government would become.
Since it was a matter of life and death for these bond traders to predict the likely direction of interest rates, they started employing economists who soon discovered that the amount of bonds the government wanted to sell depended on the rate of growth of money supply as well as the amount of public spending the government was planning to make. And once a government set a target for money supply, as many governments did in the 1970s to curb the raging inflation of that time, the markets soon figured out that governments had to choose between raising interest rates and cutting public spending plans.
The markets could now hold governments to ransom. They could force a government to cut public spending outlays or face higher interest rates. The rating agencies are merely the messenger boys for this line of thinking.
Paul Krugman and Joseph Stiglitz are not the only ones damning the immense power that financial interests have come to gain over governments. Voices against financial interests now include powerful politicians in many different countries, from many different economic persuasions. The downgrade of the US government debt by S&P may turn out to be what Thomas Birkland has called a “focusing event”, in his book titled An Introduction to the Policy Process. A “focusing event” is a sudden and rare event that sparks intense media and public attention because of its sheer magnitude. Such an event can make groups, government leaders, policy entrepreneurs, news media and the public pay attention to, and stay focused on, a problem till a solution is found.
The S&P downgrade may be one such focusing event that powerful groups may use to launch a wholesale attack on the immense power over governments that financial interests have gained in recent times.
