They were stressful times. Schroeder dropped 50 pounds from his large frame. “I was working 14-hour days,” he says. “It was tough. It turned into a total liquidity crisis, like a run on a bank. ...Bang–the thing froze.”
Today, Schroeder and his son David, who is CEO and heir apparent at DBRS, argue the firm rated the assets correctly, but misjudged the liquidity of the market in a crisis. That the market would fall apart was an eventuality no one had worked into their models. Regrets, DBRS has a few. “I don’t think you’ll get us arguing about what was our worst call,” says David Schroeder.
To Purda at Queen’s University, the freeze-up demonstrated the danger of relying heavily on ratings, especially a single rating. “Everyone was very complacent and kind of going along with it. There should have been red flags out there.” Following the ABCP imbroglio, Canadian regulators now require two ratings.
Indeed, governments around the world began to look even more skeptically at ratings agencies in the aftermath of the credit crisis. The events raised a difficult question over their role in the markets: Should ratings agencies be relied on so heavily, or merely taken as one of a variety of opinions that go into making an investment decision?
In the U.S., hearings were called to determine whether the agencies needed to be reined in, held accountable, punished, or all three. And in Europe, politicians called for a European solution–a government-owned ratings agency that would limit the EU’s dependence on private-sector American ratings agencies.
But in a fractious euro zone, reaching consensus on such a plan has proven to be impossible. So Europe reached for the next-best option: Just as U.S. regulators had done in the wake of Enron and WorldCom, European leaders decided to bring in more competition. Naturally, they looked to the only significant non-American ratings agency there was, and one that had been trying to break into Europe. Thus began DBRS’s rise to prominence on the other side of the Atlantic.
In 2008, as the credit markets in North America were imploding, DBRS was solidifying its position in Europe, where lawmakers had quietly enshrined it as rater number four. DBRS was officially on the same plane as S&P, Moody’s and Fitch. And the scenario that played out in Spain on Aug. 8 is precisely why Europe wanted a fourth player.
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Mistrust ran high in Madrid this past summer. Spain’s credit rating was being gutted by the Big Three, and billions of dollars were at stake. But what if Moody’s, S&P and Fitch had it wrong? What if the ratings agencies were merely running in a pack, feeding off one another’s dire predictions? Across Europe, politicians and public officials–led by Mario Draghi, head of the European Central Bank–grumbled about the ratings agencies. While running Italy’s central bank in 2010, Draghi complained loudly about the accuracy of the ratings agencies during the credit crisis. How could they be so powerful now? How could they be trusted?
Adding more competition doesn’t necessarily solve the problem. With agencies vying for business, debt issuers who need a high rating can theoretically shop around until they find one they like. This has been a long-held fear among critics of agencies. “What is the right level of competition? I don’t know,” says Purda. “We definitely don’t want a monopoly on these things. But at the same time, we don’t want them to be so competitive that they’re scrambling at all costs to get their ratings out there.”
Though sovereign debt is less susceptible to so-called rate shopping, since governments don’t have to pay to have their bonds rated like corporations do, the potential for political interference exists. Indeed, there is often blowback when governments don’t agree with a controversial rating. “You don’t get that from corporations,” says Dan Curry, the president of DBRS. When a government is unhappy with its rating, it shows up in the press, often as a veiled attack on the agencies’ credibility. “That’s what they do. It’s all about managing perceptions,” he says. “These are the real pros.”
In the most blatant example, S&P’s credibility was lambasted in the U.S. in August, 2011, when it downgraded the country’s credit rating one notch, from AAA to AA+. And in Europe, whenever there are controversial decisions by raters, talk of creating a European-based rater to do the job is suddenly revived. “That’s the big difference,” Curry says. “The corporations don’t start changing regulations on you.”
The way Curry sees it, politics is just one of the hazards of the job. It doesn’t mean ratings agencies bend to pressure. Not everyone agrees that complete independence is possible, however. John Coffee, a law professor at Columbia University who testified at 2009 hearings in Washington probing the independence of ratings agencies, remains convinced the firms are susceptible to outside influence, particularly when it comes to rating corporate debt.
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